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Outside Risk Aversion and the Comparative Statics of Increasing Risk in Quasi-linear Decision Models

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  • Bigelow, John P
  • Menezes, Carmen F

Abstract

Necessary and sufficient conditions are derived to determine the effect of increases in Rothschild-Stiglitz risk on optimal decisions in a class of competitive models with price uncertainty. Outside risk aversion and composite outside risk aversion are defined. The effect of increased risk on the optimal decision is controlled by composite outside risk aversion. It is decomposed into a wealth effect, controlled by downside risk aversion, and an uncertainty effect, controlled by outside risk aversion. Composite outside risk aversion is shown to be equivalent to outside risk aversion, so that the uncertainty effect controls the overall effect. Copyright 1995 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Suggested Citation

  • Bigelow, John P & Menezes, Carmen F, 1995. "Outside Risk Aversion and the Comparative Statics of Increasing Risk in Quasi-linear Decision Models," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(3), pages 643-673, August.
    • Handle: RePEc:ier:iecrev:v:36:y:1995:i:3:p:643-73
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    Cited by:

    1. Cary Deck & Harris Schlesinger, 2010. "Exploring Higher Order Risk Effects," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 77(4), pages 1403-1420.
    2. Danau, Daniel, 2020. "Prudence and preference for flexibility gain," European Journal of Operational Research, Elsevier, vol. 287(2), pages 776-785.
    3. Thomas Eichner & Andreas Wagener, 2009. "Multiple Risks and Mean-Variance Preferences," Operations Research, INFORMS, vol. 57(5), pages 1142-1154, October.
    4. X. H. Wang & Carmen Menezes, 2002. "The Precautionary Premium and the Risk-Downside Risk Tradeoff," Working Papers 0204, Department of Economics, University of Missouri, revised 16 May 2002.
    5. Thomas Eichner, 2010. "Slutzky equations and substitution effects of risks in terms of mean-variance preferences," Theory and Decision, Springer, vol. 69(1), pages 17-26, July.
    6. Menezes, Carmen F. & Henry Wang, X. & Bigelow, John P., 2005. "Duality and consumption decisions under income and price risk," Journal of Mathematical Economics, Elsevier, vol. 41(3), pages 387-405, April.
    7. Snow, Arthur, 2003. "Substitution and income effects for increases in risk," Economics Letters, Elsevier, vol. 79(3), pages 313-317, June.
    8. Hennessy, David A., 1997. "Equilibrium in production and futures markets," Journal of Economics and Business, Elsevier, vol. 49(5), pages 399-418.
    9. Jindapon, Paan & Neilson, William S., 2007. "Higher-order generalizations of Arrow-Pratt and Ross risk aversion: A comparative statics approach," Journal of Economic Theory, Elsevier, vol. 136(1), pages 719-728, September.
    10. Hennessy, David A. & Babcock, Bruce A., 1998. "Information, flexibility, and value added1," Information Economics and Policy, Elsevier, vol. 10(4), pages 431-449, December.
    11. Louis Eeckhoudt & Harris Schlesinger, 2006. "Putting Risk in Its Proper Place," American Economic Review, American Economic Association, vol. 96(1), pages 280-289, March.
    12. Eichner, Thomas & Wagener, Andreas, 2011. "Increases in skewness and three-moment preferences," Mathematical Social Sciences, Elsevier, vol. 61(2), pages 109-113, March.

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