Premium
Utility Functions whose Parameters depend on Initial Wealth
Author(s) -
Pedersen Christian S.,
Satchell S. E.
Publication year - 2003
Publication title -
bulletin of economic research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.227
H-Index - 29
eISSN - 1467-8586
pISSN - 0307-3378
DOI - 10.1111/1467-8586.00181
Subject(s) - exponential utility , quadratic equation , economics , isoelastic utility , exponential function , risk aversion (psychology) , expected utility hypothesis , asset (computer security) , class (philosophy) , mathematical economics , function (biology) , econometrics , microeconomics , mathematics , computer science , mathematical analysis , geometry , computer security , artificial intelligence , evolutionary biology , biology
Conventional one‐period utility functions in Economics assume that initial wealth only enters preferences through the definition of final wealth. Consequently, those utility functions most utilized (i.e., exponential and quadratic) have implausible risk characteristics. The authors characterize a new class of utility function whose risk parameters depend upon initial wealth and obtain several desirable results. In particular, investors with quadratic and exponential utility functions can have decreasing risk aversion, and risky assets in a quadratic utility multi‐asset environment do not have to be inferior as implied by the traditional framework.