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Incorporating Risk Aversion into Dynamic Programming Models
Author(s) -
Krautkraemer Jeffrey A.,
Kooten G. C.,
Young Douglas L.
Publication year - 1992
Publication title -
american journal of agricultural economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.949
H-Index - 111
eISSN - 1467-8276
pISSN - 0002-9092
DOI - 10.2307/1243184
Subject(s) - risk aversion (psychology) , dynamic programming , economics , expected utility hypothesis , econometrics , ambiguity aversion , time consistency , stochastic programming , independence (probability theory) , dynamic inconsistency , risk neutral , computer science , actuarial science , microeconomics , mathematical optimization , mathematical economics , mathematics , statistics , ambiguity , algorithm , programming language
Abstract Most previous stochastic dynamic programming (DP) applications have assumed that decision makers are risk neutral; however, risk permeates both intrayear and interyear relationships in most DP problems. Incorporating risk aversion to intrayear outcomes alone can violate the independence assumption of expected utility and can destabilize long‐run equilibrium returns. Aversion to riskiness of the long‐run returns suppresses the effect of sequential resolution of risk over time. Because tolerance of short‐run versus long‐run risk varies in dynamic situations, procedures for incorporating risk aversion should accommodate this variation. More research on risk averse DP formulations is needed.