Risk Aversion - Princeton University

1 Risk AversionThis chapter looks at a basic concept behind modeling individual preferences in theface of risk. As with any social science, we of course are fallible and susceptibleto second-guessing in our theories. It is nearly impossible to model many naturalhuman tendencies such as playing a hunch or being superstitious. However, wecan develop a systematic way to view choices made under uncertainty . Hopefully, ourmodels can capture the basic human tendencies enough to be useful in understandingmarket behavior towards risk. In other words, even if we are not correct in predictingbehavior under risk for every individual in every circumstance, we can still makegeneral claims about such behavior and can still make market predictions, whichafter all are based on the marginal consumer. To use (vaguely) mathematical language, the understanding of this chapter is anecessarybut notsufficientcondition to go further into the analysis. Because of theimportance of risk Aversion in decision making under uncertainty , it is worthwhileto first take an historical perspective about its development and to indicate howeconomists and decision scientists progressively have elaborated upon the tools andconcepts we now use to analyze risky choices.

importance of risk aversion in decision making under uncertainty, it is worthwhile ... theoriae novae de mensura sortis,” or “Exposition of a new theory on the mea-surement of risk.” Bernoulli’s paper, translated into English in Bernoulli (1954), is ... Each probability unit transferred yields a reduction in expected utility equal-

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  Reduction, Risks, Theory, Uncertainty, Aversion, Risk aversion

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