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D IRECTION AND I NTENSITY OF R ISK P REFERENCE AT THE T HIRD O RDER
Author(s) -
Keenan Donald C.,
Snow Arthur
Publication year - 2018
Publication title -
journal of risk and insurance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.055
H-Index - 63
eISSN - 1539-6975
pISSN - 0022-4367
DOI - 10.1111/jori.12232
Subject(s) - comparative statics , prudence , risk aversion (psychology) , preference , economics , downside risk , order (exchange) , microeconomics , upper and lower bounds , mathematical economics , econometrics , mathematics , expected utility hypothesis , financial economics , philosophy , theology , finance , portfolio , mathematical analysis
A BSTRACT In expected utility theory, aversion to risk, greater aversion, and the desire to substitute away from risk are each characterized by properties of the Arrow–Pratt index of absolute risk aversion, with comparative statics implications for such decisions as saving. At the third order, however, no single index suffices. We contrast alternative indices of third‐order risk preference and show that the substitution effect of downside risk is governed by the Schwarzian, and that where the degree of prudence governs the magnitude of precautionary saving, the Schwarzian governs the effect of background risk on the marginal rate of time preference.