Article ID: | iaor20043060 |
Country: | United States |
Volume: | 49 |
Issue: | 8 |
Start Page Number: | 1089 |
End Page Number: | 1104 |
Publication Date: | Aug 2003 |
Journal: | Management Science |
Authors: | Nau Robert F. |
Keywords: | economics |
The Pratt–Arrow measure of local risk aversion is generalized for the n-dimensional state-preference model of choice under uncertainty in which the decision maker may have inseparable subjective probabilities and utilities, unobservable stochastic prior wealth, and/or smooth nonexpected-utility preferences. Local risk aversion is measured by the matrix of derivatives of the decision maker's risk-neutral probabilities, without reference to true subjective probabilities or riskless wealth positions, and comparative risk aversion is measured without requiring agreement on true probabilities. Risk-neutral probabilities and their derivatives are shown to be sufficient statistics for approximately optimal investment and financing decisions in complete markets for contingent claims.