What is the Expected Utility theorem?
The Expected Utility theorem suggests that if certain axioms (ordering, continuity, independence) are satisfied, a utility function exists that can represent preferences, leading to a decision rule of maximizing expected utility.
What are the characteristics of a risk-averse decision maker?
A risk-averse decision maker prefers a certain outcome to a risky lottery with the same expected value. This is represented by a concave utility function.
Define certainty equivalent and risk premium.
The certainty equivalent is the amount an individual is willing to accept for a lottery instead of facing the risk, and the risk premium is the difference between the expected value and the certainty equivalent.
What are the Arrow-Pratt coefficients?
They measure risk aversion. The coefficient of absolute risk aversion (r_A) is given by -u"(z) / u'(z), and the coefficient of relative risk aversion (r_R) is z * r_A(z).
How can risk aversion be empirically measured?
Methods include incentivized lotteries (e.g., Holt and Laury, 2002), actual decisions under risk, and self-reported preferences like the DOSPERT scale.
Last changed3 months ago