Risk Aversion and Expected-Utility Theory: A Calibration Theorem

Matthew Rabin
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Matthew Rabin: University of California, Berkeley

Method and Hist of Econ Thought from EconWPA

Abstract: Within the expected-utility framework, the only explanation for risk aversion is that the utility function for wealth is concave: A person has lower marginal utility for additional wealth when she is wealthy than when she is poor. This paper provides a theorem showing that expected-utility theory is an utterly implausible explanation for appreciable risk aversion over modest stakes: Within expected-utility theory, for any concave utility function, even very little risk aversion over modest stakes implies an absurd degree of risk aversion over large stakes. Illustrative calibrations are provided.

JEL-codes: B49 D11 D81 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge and nep-ias
Date: 2001-01-02
Note: 14 pages, Acrobat .pdf
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Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwpmh:0012001

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