Approximating Risk Aversion in Decision Analysis Applications

Craig W. Kirkwood ()
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Craig W. Kirkwood: Department of Supply Chain Management, Arizona State University Tempe, Arizona 85287-4706

Decision Analysis, 2004, vol. 1, issue 1, 51-67

Abstract: This paper investigates the impact of risk aversion in decision analyses under uncertainty with a single evaluation measure and presents a simple procedure for approximately addressing risk aversion in a way that is defensible for many decisions. Specifically, a simulation study is presented that leads to guidelines for determining when an expected utility analysis should be conducted for a decision, rather than simply an expected value analysis, and what form of utility function should be used for this expected utility analysis. The simulation study shows that a sensitivity analysis using an exponential utility function should be conducted for most decision analyses, but that this sensitivity analysis can often establish, without requiring utility information from the decision maker , that no further utility analysis is required. In addition, when further utility analysis is required, the simulation study shows that this can be done in a simple way using an exponential utility function that will be accurate for many decision analyses. However, in situations where there is equal or greater downside risk than upside potential, a more detailed study of the decision maker's utility function may be necessary.

Keywords: decision analysis; risk: approximating risk aversion; utility/preferences; estimation: approximating utility functions; utility/preferences; theory: accuracy of utility function approximations (search for similar items in EconPapers)
Date: 2004
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Citations: View citations in EconPapers (28)

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Persistent link: https://EconPapers.repec.org/RePEc:inm:ordeca:v:1:y:2004:i:1:p:51-67

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