Comparing risks with reference points: A stochastic dominance approach

Dongmei Guo, Yi Hu, Shouyang Wang and Lin Zhao ()

Insurance: Mathematics and Economics, 2016, vol. 70, issue C, 105-116

Abstract: This paper develops a stochastic dominance rule for the reference-dependent utility theory proposed by Kőszegi and Rabin (2007). The new ordering captures the effects of loss aversion and can be used as a semi-parametric approach in the comparison of risks with reference points. It is analytically amenable and possesses a variety of intuitively appealing properties, including the abilities to identify both “increase in risk” and “increase in downside risk”, to resolve the Allais-type anomalies, to capture the violation of translational invariance and scaling invariance, and to accommodate the endowment effect for risk. The generalization to third-order dominance reveals that loss aversion can either reinforce or weaken prudence, depending on the location of the reference point. Potential applications of the new ordering in financial contexts are briefly discussed.

Keywords: Stochastic dominance; Reference point; Loss aversion; Downside risk; Allais-type anomalies; Endowment effect for risk (search for similar items in EconPapers)
Date: 2016
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0167668716302050
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:insuma:v:70:y:2016:i:c:p:105-116

DOI: 10.1016/j.insmatheco.2016.05.003

Access Statistics for this article

Insurance: Mathematics and Economics is currently edited by R. Kaas, Hansjoerg Albrecher, M. J. Goovaerts and E. S. W. Shiu

More articles in Insurance: Mathematics and Economics from Elsevier
Bibliographic data for series maintained by Catherine Liu ().