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Apportioning of risks via stochastic dominance

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  • Eeckhoudt, Louis
  • Schlesinger, Harris
  • Tsetlin, Ilia

Abstract

Consider a simple two-state risk with equal probabilities for the two states. In particular, assume that the random wealth variable dominates via ith-order stochastic dominance for i=M,N. We show that the 50-50 lottery dominates the lottery via (N+M)th-order stochastic dominance. The basic idea is that a decision maker exhibiting (N+M)th-order stochastic dominance preference will allocate the state-contingent lotteries in such a way as not to group the two "bad" lotteries in the same state, where "bad" is defined via ith-order stochastic dominance. In this way, we can extend and generalize existing results about risk attitudes. This lottery preference includes behavior exhibiting higher-order risk effects, such as precautionary effects and tempering effects.

Suggested Citation

  • Eeckhoudt, Louis & Schlesinger, Harris & Tsetlin, Ilia, 2009. "Apportioning of risks via stochastic dominance," Journal of Economic Theory, Elsevier, vol. 144(3), pages 994-1003, May.
    • Handle: RePEc:eee:jetheo:v:144:y:2009:i:3:p:994-1003
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    More about this item

    Keywords

    Downside risk Precautionary effects Prudence Risk apportionment Risk aversion Stochastic dominance Temperance;

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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