Microsoft PowerPoint - PoF.ppt

Utility functions: degree of risk aversionƒ 49

u

is unique up to a strictly increasi

ng affine transformation (, i.e.

u

can

be replaced by

a+bu

for any constants

a

and

b

>0 without changing the

preference ordering of

u

)

Ä

such a transformation should not change

the measure of risk aversion!

Ä

Arrow-Pratt measure of absolute risk aversion

Ä

Risk tolerance

Ä

Arrow-Pratt measure of relative risk aversion

'' '

u u

A

−

=

A

T

1

=

'' '

*

u u

w

A

w

R

−

=

=

Single-period random cash

flows: Utility theory