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Relative risk aversion must be close to 1

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  • Moshe Levy

    (The Hebrew University)

Abstract

Any utility function that is unbounded either from below or from above implies paradoxical behavior. However, these paradoxes may be regarded as irrelevant if they involve wealth levels that are realistically meaningless. Employing real-world constraints on wealth reveals that CRRA utility with relative risk aversion outside of the range 0.75–1.15 yields paradoxical choices that very few individuals, if any, would ever make. Thus, relative risk aversion must be close to 1, the value corresponding to log preferences. These results shed new light on the longstanding debate about the geometric-mean criterion and the argument of stocks for the long-run.

Suggested Citation

  • Moshe Levy, 2025. "Relative risk aversion must be close to 1," Annals of Operations Research, Springer, vol. 346(1), pages 127-135, March.
    • Handle: RePEc:spr:annopr:v:346:y:2025:i:1:d:10.1007_s10479-024-06193-0
    DOI: 10.1007/s10479-024-06193-0
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    More about this item

    Keywords

    Constant relative risk aversion (CRRA); Logarithmic utility function; Geometric mean; Stocks for the long-run;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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