Skewness preference, risk aversion, and the precedence relations on stochastic changes

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Abstract

This paper provides a general choice-theoretic characterization of the trade-off between risk and skewness, whose importance in understanding risk-taking behavior is well documented in empirical studies. The condition under which the prudence measure (Kimball 1990) characterizes the strength of an individual's downside-risk aversion against his own risk aversion is identified and interpreted in a unifying framework based on the concept of one stochastic dominant change preceding another and that of the desirability of a stochastic change. The framework is also shown to be useful for a better understanding of the Arrow-Pratt measure, the stronger Ross measure, and the coincidence of the characterizations of downside-risk aversion and prudence, as well as the relationship between stochastic dominances of different degrees. © 2005 INFORMS.
Original languageEnglish
Pages (from-to)1816-1828
Number of pages12
JournalMANAGEMENT SCIENCE
Volume51
Issue number12
DOIs
Publication statusPublished - Dec 2005

Keywords

  • Arrow-Pratt measure
  • Downside risk
  • Prudence measure
  • Risk aversion
  • Skewness preference

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