Incorporating Risk Aversion into Dynamic Programming Models

Jeffrey A. Krautkraemer, Gerrit van Kooten and Douglas L. Young

American Journal of Agricultural Economics, 1992, vol. 74, issue 4, 870-878

Abstract: Most previous stochastic dynamic programming (DP) applications have assumed that decision makers are risk neutral; however, risk permeates both intrayear and interyear relationships in most DP problems. Incorporating risk aversion to intrayear outcomes alone can violate the independence assumption of expected utility and can destabilize long-run equilibrium returns. Aversion to riskiness of the long-run returns suppresses the effect of sequential resolution of risk over time. Because tolerance of short-run versus long-run risk varies in dynamic situations, procedures for incorporating risk aversion should accommodate this variation. More research on risk averse DP formulations is needed.

Date: 1992
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