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Risk Aversion

In: Finance and the Behavioral Prospect

Author

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  • James Ming Chen

    (Michigan State University)

Abstract

If only because protective instincts are pervasive among humans and prized in many social settings,1 behavioral finance demands a credible account of risk aversion.2 That account begins with the decline of expected utility theory.3 Behavioral economics arose as a response to the limitations of conventional game theory and expected utility theory.4 Behavioral economics adds a host of considerations that elude these conventional models of utility and risk.5 Because conventional definitions of risk aversion hold the key to solving behavioral challenges such as the equity risk premium and the equity premium puzzle,6 I will now propound some of the foundations of expected utility theory. I start by presenting the absolute and relative versions of the Arrow–Pratt measures of risk aversion, named for Kenneth Arrow7 and John Pratt.8 These measures are also known as the coefficients of absolute and relative risk aversion.9

Suggested Citation

  • James Ming Chen, 2016. "Risk Aversion," Quantitative Perspectives on Behavioral Economics and Finance, in: Finance and the Behavioral Prospect, chapter 0, pages 111-135, Palgrave Macmillan.
    • Handle: RePEc:pal:qpochp:978-3-319-32711-2_6
    DOI: 10.1007/978-3-319-32711-2_6
    as

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