Improving the Risk Concept: A Revision of Arrow-Pratt Theory in the Context of Controlled Dynamic Stochastic Environments

Dan Protopopescu ()

UFAE and IAE Working Papers from Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC)

Abstract: In the literature on risk, one generally assume that uncertainty is uniformly distributed over the entire working horizon, when the absolute risk-aversion index is negative and constant. From this perspective, the risk is totally exogenous, and thus independent of endogenous risks. The traditional measures of risk-aversion are generally too weak for making comparisons between risky situations. This can be highlighted in concrete problems in finance and insurance, context for which the Arrow-Pratt measures of risk-aversion give ambiguous results (Ross 1981). We improve the Arrow-Pratt approach (1964, 1971a, 1971b), which takes into account only attitudes towards small exogenous risks, by integrating in the analysis potentially high endogenous risks that are under the control of the agent. Based on multiple theoretical and empirical arguments, this new approach offers an elegant study of the close relationship between behavior, attitude and perceived risk.

Keywords: Endogenous risk-aversion; adaptive risk management; optimal risk-aversion threshold; excessive risk-averse behavior; risk perception; changing risk behavior. (search for similar items in EconPapers)
JEL-codes: C61 D78 D81 D83 (search for similar items in EconPapers)
Pages: 43
Date: 2007-12-15, Revised 2009-12-03
New Economics Papers: this item is included in nep-upt
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:aub:autbar:727.08

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