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The Behavioural Components of Risk Aversion

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  • Davies, G.B.
  • Satchell, S.E.

Abstract

The risk premium is affected by loss aversion and probability distortions as well as utility curvature. We introduce two variants - the total risk premium relative to objective expected value, and the subjective risk premium relative to perceived expected value. Approximate solutions for each provide analogies to the Pratt-Arrow coefficient of risk aversion (showing how risk attitude depends on each behavioural component), and sufficient conditions for risk aversion. Earlier results of Levy and Levy (2002) which examined decision weights in isolation are revised and extended to show how the curvature and loss aversion conditions are affected by probability distortions.

Suggested Citation

  • Davies, G.B. & Satchell, S.E., 2004. "The Behavioural Components of Risk Aversion," Cambridge Working Papers in Economics 0458, Faculty of Economics, University of Cambridge.
    • Handle: RePEc:cam:camdae:0458
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    References listed on IDEAS

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    3. 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..
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    8. Kobberling, Veronika & Wakker, Peter P., 2005. "An index of loss aversion," Journal of Economic Theory, Elsevier, vol. 122(1), pages 119-131, May.
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    Cited by:

    1. Greg Davies, 2006. "Rethinking Risk Attitude: Aspiration as Pure Risk," Theory and Decision, Springer, vol. 61(2), pages 159-190, September.
    2. Davies, G.B., 2005. "Rethinking Risk: Aspiration as Pure Risk," Cambridge Working Papers in Economics 0507, Faculty of Economics, University of Cambridge.

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    More about this item

    Keywords

    Risk-Premium; Cumulative Prospect Theory; Loss Aversion; Decision Weights; Utility Curvature;
    All these keywords.

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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