IDEAS home Printed from https://ideas.repec.org/p/aub/autbar/727.08.html
   My bibliography  Save this paper

Improving the Risk Concept: A Revision of Arrow-Pratt Theory in the Context of Controlled Dynamic Stochastic Environments

Author

Listed:
  • DAN PROTOPOPESCU

Abstract

In the literature on risk, one generally assume that uncertainty is uniformly distributed over the entire working horizon, when the absolute risk-aversion index is negative and constant. From this perspective, the risk is totally exogenous, and thus independent of endogenous risks. The traditional measures of risk-aversion are generally too weak for making comparisons between risky situations. This can be highlighted in concrete problems in finance and insurance, context for which the Arrow-Pratt measures of risk-aversion give ambiguous results (Ross 1981). We improve the Arrow-Pratt approach (1964, 1971a, 1971b), which takes into account only attitudes towards small exogenous risks, by integrating in the analysis potentially high endogenous risks that are under the control of the agent. Based on multiple theoretical and empirical arguments, this new approach offers an elegant study of the close relationship between behavior, attitude and perceived risk.

Suggested Citation

  • Dan Protopopescu, 2007. "Improving the Risk Concept: A Revision of Arrow-Pratt Theory in the Context of Controlled Dynamic Stochastic Environments," UFAE and IAE Working Papers 727.08, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC), revised 03 Dec 2009.
    • Handle: RePEc:aub:autbar:727.08
    as

    Download full text from publisher

    File URL: http://pareto.uab.es/wp/2008/72708.pdf
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Gilboa, Itzhak, 1989. "Expectation and Variation in Multi-period Decisions," Econometrica, Econometric Society, vol. 57(5), pages 1153-1169, September.
    2. Kimball, Miles S, 1993. "Standard Risk Aversion," Econometrica, Econometric Society, vol. 61(3), pages 589-611, May.
    3. Yaari, Menahem E, 1987. "The Dual Theory of Choice under Risk," Econometrica, Econometric Society, vol. 55(1), pages 95-115, January.
    4. van de Stadt, Huib & Kapteyn, Arie & van de Geer, Sara, 1985. "The Relativity of Utility: Evidence from Panel Data," The Review of Economics and Statistics, MIT Press, vol. 67(2), pages 179-187, May.
    5. Daniel Kahneman & Amos Tversky, 2013. "Prospect Theory: An Analysis of Decision Under Risk," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 6, pages 99-127, World Scientific Publishing Co. Pte. Ltd..
    6. Drèze,Jacques, 1990. "Essays on Economic Decisions under Uncertainty," Cambridge Books, Cambridge University Press, number 9780521386975, November.
    7. Ross, Stephen A, 1981. "Some Stronger Measures of Risk Aversion in the Small and the Large with Applications," Econometrica, Econometric Society, vol. 49(3), pages 621-638, May.
    8. Machina, Mark J., 1984. "Temporal risk and the nature of induced preferences," Journal of Economic Theory, Elsevier, vol. 33(2), pages 199-231, August.
    9. Varian, Hal R., 1990. "Goodness-of-fit in optimizing models," Journal of Econometrics, Elsevier, vol. 46(1-2), pages 125-140.
    10. Kiefer, Nicholas M & Nyarko, Yaw, 1989. "Optimal Control of an Unknown Linear Process with Learning," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(3), pages 571-586, August.
    11. Matthew Rabin & Richard H. Thaler, 2013. "Anomalies: Risk aversion," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 27, pages 467-480, World Scientific Publishing Co. Pte. Ltd..
    12. John Douard, 1996. "Is Risk Neutrality Rational?," Medical Decision Making, , vol. 16(1), pages 10-11, February.
    13. Milton Friedman & L. J. Savage, 1948. "The Utility Analysis of Choices Involving Risk," Journal of Political Economy, University of Chicago Press, vol. 56(4), pages 279-279.
    14. van der Ploeg, Frederick, 1992. "Temporal risk aversion, intertemporal substitution and Keynesian propensities to consume," Economics Letters, Elsevier, vol. 39(4), pages 479-484, August.
    15. Stigler, George J & Becker, Gary S, 1977. "De Gustibus Non Est Disputandum," American Economic Review, American Economic Association, vol. 67(2), pages 76-90, March.
    16. Walsh, Vivian, 1996. "Rationality, Allocation, and Reproduction," OUP Catalogue, Oxford University Press, number 9780198287728.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Protopopescu Dan, 2008. "Improving the Effort Concept: A Revision of the Traditional Approach in the Context of Controlled Dynamic Stochastic Environments," UFAE and IAE Working Papers 739.08, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC), revised 03 Dec 2009.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Protopopescu Dan, 2008. "Improving the Effort Concept: A Revision of the Traditional Approach in the Context of Controlled Dynamic Stochastic Environments," UFAE and IAE Working Papers 739.08, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC), revised 03 Dec 2009.
    2. Christian Gollier & James Hammitt & Nicolas Treich, 2013. "Risk and choice: A research saga," Journal of Risk and Uncertainty, Springer, vol. 47(2), pages 129-145, October.
    3. Helga Fehr-Duda & Thomas Epper, 2012. "Probability and Risk: Foundations and Economic Implications of Probability-Dependent Risk Preferences," Annual Review of Economics, Annual Reviews, vol. 4(1), pages 567-593, July.
    4. Eeckhoudt, Louis, 2001. "Espérance d’utilité et nouveaux modèles de choix dans le risque : une connivence cachée," L'Actualité Economique, Société Canadienne de Science Economique, vol. 77(4), pages 499-516, décembre.
    5. Martin Herdegen & Nazem Khan & Cosimo Munari, 2024. "Risk, utility and sensitivity to large losses," Papers 2405.12154, arXiv.org.
    6. Krzysztof Kontek & Michal Lewandowski, 2018. "Range-Dependent Utility," Management Science, INFORMS, vol. 64(6), pages 2812-2832, June.
    7. Bi, Junna & Jin, Hanqing & Meng, Qingbin, 2018. "Behavioral mean-variance portfolio selection," European Journal of Operational Research, Elsevier, vol. 271(2), pages 644-663.
    8. Machina, Mark J, 2001. "Payoff Kinks in Preferences over Lotteries," Journal of Risk and Uncertainty, Springer, vol. 23(3), pages 207-260, November.
    9. Moshe Levy & Haim Levy, 2013. "Prospect Theory: Much Ado About Nothing?," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 7, pages 129-144, World Scientific Publishing Co. Pte. Ltd..
    10. Lisa L. Posey & Vickie Bajtelsmit, 2017. "Insurance and Endogenous Bankruptcy Risk: When is it Rational to Choose Gambling, Insurance, and Potential Bankruptcy?," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 42(1), pages 15-40, March.
    11. Jakusch, Sven Thorsten, 2017. "On the applicability of maximum likelihood methods: From experimental to financial data," SAFE Working Paper Series 148, Leibniz Institute for Financial Research SAFE, revised 2017.
    12. repec:lan:wpaper:3582 is not listed on IDEAS
    13. Ranoua Bouchouicha & Ferdinand M. Vieider, 2017. "Accommodating stake effects under prospect theory," Journal of Risk and Uncertainty, Springer, vol. 55(1), pages 1-28, August.
    14. Delphine Boutin & Laurène Petifour & Haris Megzari, 2022. "Instability of preferences due to Covid-19 Crisis and emotions: a natural experiment from urban Burkina Faso," Working Papers hal-03623601, HAL.
    15. Michał Lewandowski, 2017. "Prospect Theory Versus Expected Utility Theory: Assumptions, Predictions, Intuition and Modelling of Risk Attitudes," Central European Journal of Economic Modelling and Econometrics, Central European Journal of Economic Modelling and Econometrics, vol. 9(4), pages 275-321, December.
    16. George Wu, 1999. "Anxiety and Decision Making with Delayed Resolution of Uncertainty," Theory and Decision, Springer, vol. 46(2), pages 159-199, April.
    17. Hiroaki HAYAKAWA, 2017. "Socio-cultural Evolution, Institutionalized Dispositions, And Rational Expressive Behavior," Journal of Economic and Social Thought, KSP Journals, vol. 4(1), pages 1-40, March.
    18. Firpo, Sergio & Galvao, Antonio F. & Kobus, Martyna & Parker, Thomas & Rosa-Dias, Pedro, 2020. "Loss Aversion and the Welfare Ranking of Policy Interventions," IZA Discussion Papers 13176, Institute of Labor Economics (IZA).
    19. Epper, Thomas & Fehr-Duda, Helga, 2017. "A Tale of Two Tails: On the Coexistence of Overweighting and Underweighting of Rare Extreme Events," Economics Working Paper Series 1705, University of St. Gallen, School of Economics and Political Science.
    20. Terence C. Burnham & Aimee Dunlap & David W. Stephens, 2015. "Experimental Evolution and Economics," SAGE Open, , vol. 5(4), pages 21582440156, November.
    21. Karine Darjinoff & Francois Pannequin, 2000. "Demande d'assurance : Faut-il abandonner le critère de l'espérance d'utilité ?," Cahiers de la Maison des Sciences Economiques bla00004, Université Panthéon-Sorbonne (Paris 1).

    More about this item

    Keywords

    Endogenous risk-aversion; adaptive risk management; optimal risk-aversion threshold; excessive risk-averse behavior; risk perception; changing risk behavior.;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D78 - Microeconomics - - Analysis of Collective Decision-Making - - - Positive Analysis of Policy Formulation and Implementation
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:aub:autbar:727.08. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Xavier Vila (email available below). General contact details of provider: https://edirc.repec.org/data/ufuabes.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.