Parametric Characterizations of Risk Aversion and Prudence

By Fatma Lajeria and Lars Tyge Nielsen

Economic Theory 15 (2000), 469-476

Abstract

Our first main result says whether one decision maker is more risk averse than another can be determined from their attitudes toward a given two-parameter family of risks. When all risks belong to this family, risk aversion can be compared even when initial wealth is random. Our second main result solves a long-standing problem in mean-variance analysis: what is the interpretation of the concavity of utility as a function of mean and variance? We show that in the case of normal distributions, this utility function is concave if and only if the agent has decreasing prudence.