Within the expected-utility framework, the only explanation for risk aversion is that the utility function for wealth is concave: A person has lower marginal utility for additional wealth when she is wealthy than when she is poor. This paper provides a theorem showing that expected-utility theory is an utterly implausible explanation for apprecia-
ble risk aversion over modest stakes: Within expected-utility theory, for any concave utility function, even very little risk aversion over modest stakes implies an absurd degree of risk aversion over large stakes. Illustrative calibrations are provided
The paper, or my comment? I interpreted the paper as an attack on (explanatory) models of risk aversion that are based on this (quite general) type of utility curve, with the conclusion that observed behavior can’t be motivated by such a curve.
Conversly, if you’d pay much more than this, you are absurdly risk averse: Here’s a pdf of a classic paper by Rabin: Risk Aversion and Expected-Utility Theory: A Calibration Theorem
Abstract:
This seems to make an unwarranted assumption about exactly how the marginal utility diminishes.
The paper, or my comment? I interpreted the paper as an attack on (explanatory) models of risk aversion that are based on this (quite general) type of utility curve, with the conclusion that observed behavior can’t be motivated by such a curve.
This is a great example of If It’s Worth Doing, It’s Worth Doing With Made-Up Statistics. If the assumption is your True Rejection, it’s worth playing around with alternate models to see if you can get a different answer. The simple truth is that humans are dynamically inconsistent.