Risk Aversion (risk + aversion)

Distribution by Scientific Domains
Distribution within Business, Economics, Finance and Accounting

Kinds of Risk Aversion

  • absolute risk aversion
  • constant relative risk aversion
  • relative risk aversion

  • Selected Abstracts


    ECONOMIC INQUIRY, Issue 1 2010
    This research examines whether women have higher risk aversion than men as demonstrated by their retirement asset allocation. The analysis is extended to investigate how retirement asset investment decisions are made in married households. Initial results suggest controlling for demographic, income, and wealth differences lead to no significant difference in the proportion of retirement assets held in stocks between women and male faculty. For married households with joint investment decision making, results indicate that gender differences are a significant factor in explaining individual retirement asset allocation. Our estimates imply that women faculty are more risk averse than their male spouse. (JEL J16, G11, D10) [source]


    ECONOMIC INQUIRY, Issue 2 2008
    We study how three interrelated phenomena,excess stock returns and risk relation, risk aversion, and asymmetric volatility movement,change over business cycles. Using an asymmetric generalized autoregressive conditional heteroskedasticity in mean model and a Markov switching model, we find that excess stock return increases and asymmetric volatility movement is weakened during boom periods. This suggests that investors become more risk-averse during boom periods (i.e., procyclical risk aversion), which we confirm using a calibration of a simple equilibrium model. (JEL C32, E32, G12) [source]


    Abstract This paper examines the effect of risk aversion on the optimal rotation when the stumpage price is stochastic. Assuming that the stumpage price is normally distributed, we show that the optimal rotation under risk aversion may be shorter than, equal to, or longer than the corresponding optimal rotation under risk neutrality. Which of these cases holds true depends on the interest rate and the real regeneration cost, and can be determined based on the marginal variance (i.e., the derivative of the variance function with respect to rotation age) evaluated at the optimal rotation under risk neutrality. Furthermore, we show that there exists a monotone continuous curve, which divides the interest rate-regeneration cost space into two regions where risk aversion affects the optimal rotation differently. For a given interest rate, risk aversion shortens (prolongs) the optimal rotation if the regeneration cost lies below (above) the curve. Along the separating curve the optimal rotation under risk aversion coincides with the optimal rotation under risk neutrality. Two examples are presented to demonstrate the separating curve and the impacts of risk aversion on the optimal rotation. [source]


    Dave Berger
    Abstract We adopt realized covariances to estimate the coefficient of risk aversion across portfolios and through time. Our approach yields second moments that are free from measurement error and not influenced by a specified model for expected returns. Supporting the permanent income hypothesis, we find risk aversion responds to consumption-smoothing behavior. As income increases, or as the consumption-to-income ratio falls, relative risk aversion decreases. We also document variation in risk aversion across portfolios: risk aversion is highest for small and value portfolios. [source]

    Inequality Aversion versus Risk Aversion

    ECONOMICA, Issue 277 2003
    Yoram Kroll
    Inequality aversion and risk-aversion are widely assumed in economic models; however existing economic literature fails to distinguish between the two. This paper presents methodology and a laboratory experiment, which separates inequality aversion from risk aversion. In a set of laboratory experiments, subjects had to choose between two risky alternatives which pay meaningful prizes with the same individual risk but different levels of egalitarianism. Thus, the choice of the more egalitarian alternative implies a higher level of inequality aversion. The experiment was conducted among children, some of whom live on a communal system (kibbutz) and some in the city. [source]

    The Roots of Entrepreneurship and Labour Demand: Individual Ability and Low Risk Aversion

    ECONOMICA, Issue 269 2001
    C. M. Van Praag
    This paper develops a model as a means to explain business formation and the labour demand of entrepreneurs. An individual will become an entrepreneur if the expected rewards surpass the wages of employment, and the expected rewards depend on an assessment of individual ability and on risk attitude. Actual ability determines success and hence the demand for wage labour of the firm. In equilibrium these factors govern the distribution of a given workforce over entrepreneurs and employees. The model is fitted to Dutch survey data. The empirical results confirm the importance of both risk-taking and ability for successful entrepreneurship. [source]

    Managers and Productive Investment Decisions: The Impact of Uncertainty and Risk Aversion

    Jacques-Bernard Sauner-Leroy
    The main purpose of this study is to examine the links among uncertainty, manager's risk-taking attitude, and the level of productive investment of small and medium-size enterprises. The analysis makes use of qualitative data collected by the Bank of France in a national survey conducted in 1999 on the strategic behavior of 1,578 French industrial small and medium-size firms. A multiple regression model is used to test the impact of uncertainty and risk aversion on investment decisions. Results support the hypothesis of the literature stating that productive investment is correlated positively with risk taking and is correlated negatively with uncertainty. [source]

    Risk Aversion and the Efficiency Wage Contract

    LABOUR, Issue 1 2004
    Ouassila Chouikhi
    This could be due to informational problems. Reformulating the Shapiro and Stiglitz model as a sequential game, this paper examines the relations between the terms of the efficiency wage contract offered by a firm and the responses of a worker, under incomplete information about the degree of risk aversion of the firm and the worker. It shows that under incomplete information about the degree of risk aversion of the worker, shirking can emerge as an equilibrium phenomenon. For any efficiency wage contract, a worker will shirk if the degree of risk aversion of the worker is less than that corresponding to the contract. [source]

    Risk Aversion, Transparency, and Market Performance

    THE JOURNAL OF FINANCE, Issue 2 2002
    M. Ángeles De Frutos
    Using a model of market making with inventories based on Biais (1993), we find that investors obtain more favorable execution prices, and they hence invest more, when markets are fragmented. In our model, risk-averse dealers use less aggressive price strategies in more transparent markets (centralized) because quote dissemination alleviates uncertainty about the prices quoted by other dealers and, hence, reduces the need to compete aggressively for order flow. Further, we show that the move toward greater transparency (centralization) may have detrimental effects on liquidity and welfare. [source]

    Integration of VaR and expected utility under departures from normality

    Peter J. Barry
    Cornish,Fisher expansion; Expected utility; Risk aversion; Value-at-Risk Abstract This article identifies the level of the expected utility (EU) risk aversion and Value-at-Risk (VaR) confidence level that yield the same choice from a given distribution of outcomes, and thus allow for consistent application of the two criteria. The result for a given distribution is an explicit mapping between risk aversion under EU and VaR, for both normal and nonnormal distributions. The Cornish,Fisher expansion is used to establish adjusted mean-deviates for nonnormal outcome distributions and the investor's preference function is expanded to include elements for variance, skewness, and excess kurtosis. A farm-level application with nonnormal revenue distribution illustrates these approaches. [source]

    Disruption-management strategies for short life-cycle products

    Brian Tomlin
    Abstract Supplier diversification, contingent sourcing, and demand switching (whereby a firm shifts customers to a different product if their preferred product is unavailable), are key building blocks of a disruption-management strategy for firms that sell multiple products over a single season. In this article, we evaluate 12 possible disruption-management strategies (combinations of the basic building-block tactics) in the context of a two-product newsvendor. We investigate the influence of nine attributes of the firm, its supplier(s), and its products on the firs preference for the various strategies. These attributes include supplier reliability, supplier failure correlation, payment responsibility in the event of a supply failure, product contribution margin, product substitutability, demand uncertainties and correlation, and the decision makes risk aversion. Our results show that contingent sourcing is preferred to supplier diversification as the supply risk (failure probability) increases, but diversification is preferred to contingent sourcing as the demand risk (demand uncertainty) increases. We find that demand switching is not effective at managing supply risk if the products are sourced from the same set of suppliers. Demand switching is effective at managing demand risk and so can be preferred to the other tactics if supply risk is low. Risk aversion makes contingent sourcing preferable over a wider set of supply and demand-risk combinations. We also find a two-tactic strategy provides almost the same benefit as a three-tactic strategy for most reasonable supply and demand-risk combinations. © 2009 Wiley Periodicals, Inc. Naval Research Logistics, 2009 [source]


    Joan Costa-Font
    ABSTRACT,:,Captivity to a mainstream public insurer, is hypothesized to constrain the choice of purchasing private health insurance, by influencing risk attitudes. Namely, risk averse individuals are more likely to stay captive to the National Health System (NHS). To empirically test this hypothesis we use a small scale database from Catalonia to explore the determinants of private health insurance (PHI) purchase under different forms of captivity along with a measure of risk attitudes. Our results confirm that the captivity corrections are significant and can potentially bias the estimates of the demand for PHI. Risk aversion increases the probability of an individual being captive to the NHS. The latter suggests a potential behavioural (or cultural) mechanism to isolate the influence of risk attitudes on the demand for PHI in publicly financed health systems. [source]

    Consumption Over the Life Cycle

    ECONOMETRICA, Issue 1 2002
    Pierre-Olivier Gourinchas
    This paper estimates a structural model of optimal life-cycle consumption expenditures in the presence of realistic labor income uncertainty. We employ synthetic cohort techniques and Consumer Expenditure Survey data to construct average age-profiles of consumption and income over the working lives of typical households across different education and occupation groups. The model fits the profiles quite well. In addition to providing reasonable estimates of the discount rate and risk aversion, we find that consumer behavior changes strikingly over the life cycle. Young consumers behave as buffer-stock agents. Around age 40, the typical household starts accumulating liquid assets for retirement and its behavior mimics more closely that of a certainty equivalent consumer. Our methodology provides a natural decomposition of saving and wealth into its precautionary and life-cycle components. [source]


    ECONOMIC INQUIRY, Issue 2 2008
    We study how three interrelated phenomena,excess stock returns and risk relation, risk aversion, and asymmetric volatility movement,change over business cycles. Using an asymmetric generalized autoregressive conditional heteroskedasticity in mean model and a Markov switching model, we find that excess stock return increases and asymmetric volatility movement is weakened during boom periods. This suggests that investors become more risk-averse during boom periods (i.e., procyclical risk aversion), which we confirm using a calibration of a simple equilibrium model. (JEL C32, E32, G12) [source]


    ECONOMIC INQUIRY, Issue 1 2008
    This article examines whether noncognitive skills,measured both by personality traits and by economic preference parameters,influence cognitive tests' performance. The basic idea is that noncognitive skills might affect the effort people put into a test to obtain good results. We experimentally varied the rewards for questions in a cognitive test to measure to what extent people are sensitive to financial incentives. To distinguish increased mental effort from extra time investments, we also varied the questions' time constraints. Subjects with favorable personality traits such as high performance motivation and an internal locus of control perform relatively well in the absence of rewards, consistent with a model in which trying as hard as you can is the best strategy. In contrast, favorable economic preference parameters (low discount rate, low risk aversion) are associated with increases in time investments when incentives are introduced, consistent with a rational economic model in which people only invest when there are monetary returns. The main conclusion is that individual behavior at cognitive tests depends on noncognitive skills. (JEL J20, J24) [source]

    What drives spreads in the euro area government bond market?

    ECONOMIC POLICY, Issue 58 2009
    Simone Manganelli
    Summary Spreads between euro area government bond yields are related to short-term interest rates, which are in turn related to market liquidity, to cyclical conditions, and to investors' incentives to take risk. In theory, lower interest rates are associated with lower degrees of risk aversion and smaller government bond spreads. Empirically, the Eurosystem's short-term interest rates are positively related to those spreads, which our econometric model finds to include significant and policy-relevant default risk and liquidity risk components. , Simone Manganelli and Guido Wolswijk [source]

    Should we beware of the Precautionary Principle?

    ECONOMIC POLICY, Issue 33 2001
    Christian Gollier
    How should society deal with risks when there is scientific uncertainty about the size of these risks? There has been much recent discussion of the Precautionary Principle, which states that lack of full scientific knowledge should not be used as a reason to postpone cost,effective preventive measures. We show in this paper that the Precautionary Principle contradicts one important intuition about the right way to act in the face of risk, namely the principle of ,looking before you leap'. When we expect to learn more about the future, the effectiveness of our preventive measures will be greater if we learn before we act. However, a number of other ways of taking uncertainty into account are consistent with a reasonable interpretation of the Precautionary Principle. First, postponing preventive measures may increase our vulnerability to damage, which induces a precautionary motive for risk,prevention, similar to the precautionary savings motive. Secondly, stronger preventive actions often yield more flexibility for the future, so that acting early has an option value. Thirdly, when better information comes from a process of learning,by,doing, the risk associated with early events is amplified by the information they yield about the future. This plays a role analogous to that of an increase in risk aversion, making us more cautious. Fourthly, because imperfect knowledge of the risk makes it difficult to insure, the social cost of risk should include a risk premium. Finally, uncertainty about the economic environment enjoyed by future generations should be taken into account. This raises the benefit of acting early to prevent long,term risks. If the Precautionary Principle sometimes gives good and sometimes gives bad advice, there is no escape from the need to undertake a careful cost,benefit analysis. We show that standard cost,benefit analysis can be refined to take account of scientific uncertainty, in ways that balance the Precautionary Principle against the benefits of waiting to learn before we act. Furthermore, it is important that they be used to do so, for instinct is an unreliable guide in such circumstances. Abandoning cost,benefit analysis in favour of simple maxims can result in some seriously misleading conclusions. [source]

    Inequality Aversion versus Risk Aversion

    ECONOMICA, Issue 277 2003
    Yoram Kroll
    Inequality aversion and risk-aversion are widely assumed in economic models; however existing economic literature fails to distinguish between the two. This paper presents methodology and a laboratory experiment, which separates inequality aversion from risk aversion. In a set of laboratory experiments, subjects had to choose between two risky alternatives which pay meaningful prizes with the same individual risk but different levels of egalitarianism. Thus, the choice of the more egalitarian alternative implies a higher level of inequality aversion. The experiment was conducted among children, some of whom live on a communal system (kibbutz) and some in the city. [source]


    EVOLUTION, Issue 12 2007
    H. Allen Orr
    It is well known that (1) natural selection typically favors an allele with both a large mean fitness and a small variance in fitness; and (2) investors typically prefer a portfolio with both a large mean return and a small variance in returns. In the case of investors, this mean,variance trade-off reflects risk aversion; in the case of evolution, the mathematics is straightforward but the result is harder to intuit. In particular, it is harder to understand where, in the mathematics of natural selection, risk aversion arises. Here I present a result that suggests a simple answer to this question. Although my answer is essentially identical to one offered previously, my path to it differs somewhat from previous approaches. Some may find this new approach easier to intuit. [source]

    Measuring Investment Distortions when Risk-Averse Managers Decide Whether to Undertake Risky Projects

    Robert Parrino
    We create a dynamic model in which a self-interested, risk-averse manager makes corporate investment decisions at a levered firm with characteristics typical of public US firms. We examine the magnitude of distortions in those decisions when a new project changes firm risk and find expected changes in the values of future tax shields and bankruptcy costs to be important factors. We evaluate the extent to which these distortions vary with firm leverage, debt duration, project size, managerial risk aversion, managerial non-firm wealth, and the structure of management compensation packages [source]

    Financial Intermediaries and Interest Rate Risk: II

    Sotiris K. Staikouras
    The current work extends and updates the previous survey (Staikouras, 2003) by looking at other aspects of the financial institutions' yield sensitivity. The study starts with an extensive discussion of the origins of asset-liability management and the subsequent work to identify effective ways of measuring and managing interest rate risk. The discussion implicates both regulatory and market-based approaches along with any issues surrounding their applicability. The literature is enriched by recognizing that structural and regulatory shifts affect financial institutions in different ways depending on the size and nature of their activities. It is also noted that such shifts could change the bank's riskiness, and force banks to adjust their balance sheet size by altering their maturity intermediation function. Besides yield changes, market cycles are also held responsible for asymmetric effects on corporate values. Furthermore, nonstandard investigations are considered, where embedded options and basis risk are significant above and beyond the intermediary's rate sensitivity, while shocks to the slope of the yield curve is identified as a new variable. When the discount privilege is modeled as an option, it is shown that its value is incorporated in the equities of qualifying banks. Finally, volatility clustering is further established while constant relative risk aversion is not present in the U.S. market. Although some empirical findings may be quite mixed, there is a general consensus that all forms of systematic risk, risk premia, and the risk-return trade-off do exhibit some form of variability, not only over time but also across corporate sizes and segments. [source]

    The Subjective Valuation of Indexed Stock Options and Their Incentive Effects

    FINANCIAL REVIEW, Issue 2 2006
    A. Louis Calvet
    G13; G12; J33; J32 Abstract We analyze the potential role of indexed stock options in future pay-for-performance executive compensation contracts. We present a unified framework for index-linked stock options, discuss their incentive effects, argue that indexation schemes based on the capital-asset pricing model (CAPM) are the most suitable for executive compensation, and derive a subjective pricing model for the class of CAPM-based indexed stock options. Contrary to earlier work, executives would not be motivated to take on investment projects with high idiosyncratic risk once their lack of wealth diversification and degree of risk aversion are factored into the analysis. [source]

    Real options for precautionary fisheries management

    FISH AND FISHERIES, Issue 2 2008
    Eli P Fenichel
    Abstract The 1996 Food and Agriculture Organization's (FAO) ,Guidelines on the Precautionary Approach to Fisheries and Species Introduction' raise important issues for fisheries managers, but fail to prescribe an approach for risk management. The distinguishing characteristics of the ,precautionary approach' are the inclusion of uncertainty and ,an elaboration on the burden of proof'. The FAO precautionary approach emphasizes that managers should be risk-averse, but does not provide tools for determining the appropriate degree of risk aversion. Consequently, application of the precautionary approach often leads to decision-making based on ad hoc safety margins. These safety margins are seldom chosen with explicit consideration of trade-offs. If the emphasis was shifted to choosing between competing uncertainties, then managers could manage risk. By attempting to avoid risk, managers may gain exposure to other risks and perhaps miss valuable opportunities. We place fishery management problems within the rubric of ,real investment' problems, and compare and contrast the consideration of risk by alternative investment frameworks. We show that traditional investment frameworks are inappropriate for fishery management, and furthermore, that traditional precautionary approaches are arbitrary and without basis in decision theory. Quantitative decision-making techniques, such as formal decision analysis (FDA), enable integration of competing hypotheses that help alleviate burden-of-proof issues. These techniques help analysts consider sources of uncertainty. FDA, however, can still be subject to arbitrary safety margins because such analyses often focus on determining which strategies best achieve, or avoid, targets that have been established without complete consideration of trade-offs. A managerial finance approach, real options analysis (ROA), is an alternative and complementary decision-making technique that enables managers to compute precautionary adjustments that couple the size of the ,safety margin' with the amount of uncertainty, thereby optimizing risk exposure and avoiding the need for arbitrary safety margins. We illustrate the advantages of an approach that combines FDA and ROA, using a heuristic example about a decision to re-introduce Atlantic salmon (Salmo salar L.) into Lake Ontario. Finally, we provide guidance on applying ROA to other fishery problems. The precautionary approach requires that managers consider risk, but considering risk is not the same as managing it. Here ROA is useful. [source]

    Do aggressive funds reallocate their portfolios aggressively?

    ACCOUNTING & FINANCE, Issue 3 2009
    Kevin C. H. Chiang
    D9; G11 Abstract This study examines pairs of asset allocation mutual funds that are controlled for all informational attributes, except for the level of risk aversion. Standard mean-variance models of portfolio choice suggest that the percentage rebalancing of common stocks in aggressive funds would be the same as that in conservative funds. However, this study finds the rebalancing of common stocks in aggressive funds to be disproportionally less intense. [source]

    On the Interaction of Risk and Time Preferences: An Experimental Study

    Vital Anderhub
    Experimental studies of risk and time preference typically focus on one of the two phenomena. The goal of this paper is to investigate the (possible) correlation between subjects' attitude to risk and their time preference. For this sake we ask 61 subjects to price a simple lottery in three different scenarios. At the first, the lottery premium is paid ,now'. At the second, it is paid ,later'. At the third, it is paid ,even later,. By comparing the certainty equivalents offered by the subjects for the three lotteries, we test how time and risk preferences are interrelated. Since the time interval between ,now' and ,later' is the same as between ,later' and ,even later', we also test the hypothesis of hyperbolic discounting. The main result is a statistically significant negative correlation between subjects' degrees of risk aversion and their (implicit) discount factors. Moreover, we show that the negative correlation is independent of the method used to elicit certainty equivalents (willingness to pay versus willingness to accept). [source]

    Investment in antiviral drugs: a real options approach

    HEALTH ECONOMICS, Issue 10 2010
    Arthur E. Attema
    Abstract Real options analysis is a promising approach to model investment under uncertainty. We employ this approach to value stockpiling of antiviral drugs as a precautionary measure against a possible influenza pandemic. Modifications of the real options approach to include risk attitude and deviations from expected utility are presented. We show that risk aversion counteracts the tendency to delay investment for this case of precautionary investment, which is in contrast to earlier applications of risk aversion to real options analysis. Moreover, we provide a numerical example using real world data and discuss the implications of real options analysis for health policy. Suggestions for further extensions of the model and a comparison with the expected value of information analysis are put forward. Copyright © 2009 John Wiley & Sons, Ltd. [source]

    Analysing risk attitudes to time

    HEALTH ECONOMICS, Issue 6 2010
    Adam Oliver
    Abstract The assumption of risk neutrality over discounted life years underlies the standard QALY model of individual preferences over health outcomes, and is thus implicitly assumed by NICE and other health technology advisory bodies worldwide. The primary objective of this article is to report a study to test the assumption in a convenience sample of 30 respondents with use of the probability equivalence version of the standard gamble. The results indicate considerable risk aversion over life years, and therefore call into question the standard assumption of risk neutrality in practical cost-utility analyses (CUA). A secondary objective is to observe whether risk aversion can be reduced through the use of the lottery equivalents method, under the hypothesis that the gambling effect can be lessened with this instrument. In a separate convenience sample of 40 respondents, however, the observed level of risk aversion was at least that seen in the standard gamble. Further research is warranted to ascertain whether risk aversion over discounted life years is a generalisable concern. Copyright © 2009 John Wiley & Sons, Ltd. [source]

    Explaining the characteristics of the power (CRRA) utility family

    HEALTH ECONOMICS, Issue 12 2008
    Peter P. WakkerArticle first published online: 22 JAN 200
    Abstract The power family, also known as the family of constant relative risk aversion (CRRA), is the most widely used parametric family for fitting utility functions to data. Its characteristics have, however, been little understood, and have led to numerous misunderstandings. This paper explains these characteristics in a manner accessible to a wide audience. Copyright © 2008 John Wiley & Sons, Ltd. [source]


    Olivier Armantier
    This article illustrates how the joint elicitation of subjective probabilities and preferences may help us understand behavior in games. We conduct an experiment to test whether biased probabilistic beliefs may explain overbidding in first-price auctions. The experimental outcomes indicate that subjects underestimate their probability of winning the auction, and indeed overbid. When provided with feedback on the precision of their predictions, subjects learn to make better predictions, and to curb significantly overbidding. The structural estimation of different behavioral models suggests that biased probabilistic beliefs are a driving force behind overbidding, and that risk aversion plays a lesser role than previously believed. [source]

    Capital Asset Pricing Model and the Risk Appetite Index: Theoretical Differences, Empirical Similarities and Implementation Problems,

    Marcello Pericoli
    We perform a thorough analysis of the Risk Appetite Index (RAI), a measure of changes in risk aversion proposed by Kumar and Persaud (2002). Building on Misina's study (2003), we first argue that the theoretical assumptions granting that the RAI correctly distinguishes between changes in risk and changes in risk aversion are very restrictive. Then, by comparing the RAI with a measure of risk aversion obtained from the Capital Asset Pricing Model (CAPM), we find that the estimates are surprisingly similar. We prove that if the variance of returns is sufficiently smaller than the variance of asset riskiness, then RAI and CAPM provide essentially the same information about risk aversion. We also show, however, that RAI and CAPM suffer from exactly the same implementation problems , the main one being the difficulty in measuring ex-ante returns. At high and medium frequencies, the standard method of measuring ex-ante with ex-post returns may generate negative risk aversion and other inconsistencies. Hence, future research is needed to address this problem. [source]