Example of the “unappealingness” of constant absolute risk aversion. Say my u-curve were u(x) = 1-exp(-x/400K) over all ranges. What is my value for a 50-50 shot at 10M?
Answer: around $277K. (Note that it is the same for a 50-50 shot at $100M)
Given the choice, I would certainly choose a 50-50 shot at $10M over $277K. This is why over larger ranges, I don’t use an exponential u-curve.
However, it is a good approximation over a range that contains almost all the decisions I have to make. Only for huge decisions to I need to drag out a more complicated u-curve, and they are rare.
Example of the “unappealingness” of constant absolute risk aversion. Say my u-curve were u(x) = 1-exp(-x/400K) over all ranges. What is my value for a 50-50 shot at 10M?
Answer: around $277K. (Note that it is the same for a 50-50 shot at $100M)
Given the choice, I would certainly choose a 50-50 shot at $10M over $277K. This is why over larger ranges, I don’t use an exponential u-curve.
However, it is a good approximation over a range that contains almost all the decisions I have to make. Only for huge decisions to I need to drag out a more complicated u-curve, and they are rare.