Document Type

Journal article

Source Publication

Journal of Economic Theory

Publication Date

11-1-2014

Volume

154

First Page

403

Last Page

422

Keywords

Background risk, Consumption risk in business cycles, Equity premium puzzle, Expected utility theory, First-order conditional dependent risk aversion, Rank-dependent expected utility model

Abstract

Expected utility functions are limited to second-order (conditional) risk aversion, while non-expected utility functions can exhibit either first-order or second-order (conditional) risk aversion. We extend the concept of orders of conditional risk aversion to orders of conditional dependent risk aversion. We show that first-order conditional dependent risk aversion is consistent with the framework of the expected utility hypothesis. Our theoretical result proposes new insights into economic and financial applications such as the equity premium puzzle, the cost of business cycles, and stock market participation. Our model is compared to the rank-dependent expected utility model.

DOI

10.1016/j.jet.2014.09.019

Print ISSN

00220531

E-ISSN

10957235

Publisher Statement

Copyright © 2014 Elsevier Inc.

Access to external full text or publisher's version may require subscription.

Additional Information

This paper is also available at Social Science Research Network at http://ssrn.com/abstract=2197741

Full-text Version

Accepted Author Manuscript

Recommended Citation

Dionne, G., & Li, J. (2014). When can expected utility handle first-order risk aversion? Journal of Economic Theory, 154, 403-422. doi: 10.1016/j.jet.2014.09.019