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A Gentle Introduction to Risk Aversion and Utility Theory

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  • David A. Cather

Abstract

While the topics of risk aversion and utility theory have been discussed extensively in the academic literature on risk and insurance, this literature does not include a pedagogical discussion that is widely accessible for classroom use. This article provides a practical introduction to risk aversion that is designed for readers with little prerequisite course work in economics or statistics. We describe a simple model of insurance demand that can be applied to the property, liability, life, and health insurance markets. We also demonstrate how risk aversion affects a variety of real‐life insurance decisions made under conditions of uncertainty, including how much the market will bear to pay for insurance administrative expenses and how demand varies for different types of auto insurance coverage. Exercises and practice problems are provided so that readers can test their mastery of the concepts presented in the article. An instructional note on using this article to teach risk aversion in the classroom is also provided.

Suggested Citation

  • David A. Cather, 2010. "A Gentle Introduction to Risk Aversion and Utility Theory," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 13(1), pages 127-145, March.
    • Handle: RePEc:bla:rmgtin:v:13:y:2010:i:1:p:127-145
    DOI: j.1540-6296.2009.01173.x
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    File URL: https://doi.org/10.1111/j.1540-6296.2009.01173.x
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    References listed on IDEAS

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    1. Dickson,David C. M., 2005. "Insurance Risk and Ruin," Cambridge Books, Cambridge University Press, number 9780521846400.
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    Cited by:

    1. Waweru, Caroline Waithira & Nyikal, Rose & Busienei, John R, 2017. "An Analysis Of Risk Attitudes And Risk Management Strategies Among Dairy Farmers In Murang’A County, Kenya," Dissertations and Theses 271063, University of Nairobi, Department of Agricultural Economics.
    2. Bart Stemmet, 2011. "Hedging one’s happiness – Should a sports fan bet on the opponent?," Working Papers 20/2011, Stellenbosch University, Department of Economics.
    3. David A. Cather, 2018. "Cream Skimming: Innovations in Insurance Risk Classification and Adverse Selection," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 21(2), pages 335-366, September.
    4. Waithira, Waweru Caroline, 2017. "An Analysis Of Risk Attitudes And Risk Management Strategies Among Dairy Farmers In Murang’A County, Kenya," Research Theses 276428, Collaborative Masters Program in Agricultural and Applied Economics.

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