A simple measure of risk aversion in the large and an application

Parkash Chander

No 2000041, LIDAM Discussion Papers CORE from Université catholique de Louvain, Center for Operations Research and Econometrics (CORE)

Abstract: We introduce a simple measure of risk aversion in the large. Besides satisfying properties which are conceptually analogous to the usual properties of the Arrow-Pratt measure, the index of risk aversion in the large leads to a stronger concept of decreasing risk aversion, which necessarily implies decreasing absolute risk aversion but not necessarily non-increasing relative risk aversion. The index also leads to a recursive procedure for refining the set of vN - M utility functions. We show that the majority of refinements considered in the theory of multiple risk bearing including that of mixed risk aversion can be obtained from this procedure. Finally, as an illustration, we apply the measure to characterize individual behaviour under uncertainty in the principal-agent model of optimal income tax enforcement in which the risks involved are indeed large.

Keywords: expected utility; risk aversion; certainty equivalent; multiple risk bearing; principal-agent; audit probability. (search for similar items in EconPapers)
JEL-codes: D80 D81 D82 H21 (search for similar items in EconPapers)
Date: 2000-08
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Citations: View citations in EconPapers (5)

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