What's in a u?

Antonio Penta and Larbi Alaoui

No 1494, Working Papers from Barcelona School of Economics

Abstract: We revisit the long-lasting debate about the meaning of the utility function used in the standard Expected Utility (EU) model. Despite the common view that EU forces risk aversion and diminishing marginal utility of wealth to be pegged to one another, here we show that this is not the case. Marginal utility for money is an input into risk attitude, but it is not its sole determinant. The attitude towards 'pure risk' is also a contributing factor, and it is independent from the former. We discuss several theoretical implications of this result, for the following topics: (i) non-neutral risk attitudes for profit maximizing firms; (ii) risk-aversion over time lotteries in the presence of discounting; (iii) the equity premium puzzle. We also discuss matters of identification: (i) for firms; (ii) via proxies ; (iii) via standard MLE-methods under parametric restrictions; and (iv) cross-context elicitation in multi-dimensional settings, and its relationship with the methods and results from the psychology literature.

Keywords: Risk Aversion; utility function; marginal utility (search for similar items in EconPapers)
JEL-codes: C72 C91 C92 D80 D91 (search for similar items in EconPapers)
Date: 2025-06
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Persistent link: https://EconPapers.repec.org/RePEc:bge:wpaper:1494

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