Changes in Risky Benefits and in Risky Costs: A Question of the Right Order

Author:

Menegatti Mario1ORCID,Peter Richard2ORCID

Affiliation:

1. Dipartimento di Scienze Economiche e Aziendali, Universita degli Studi di Parma, 43125 Parma, Italy;

2. Department of Finance, University of Iowa, Iowa City, Iowa 52242

Abstract

We organize and extend findings on the comparative static effects of risk changes on optimal behavior in a unifying expected utility model. We determine restrictions on preferences for clear-cut results. Risk increases of a benefit are compensated by lowering exposure to risk. For risk increases of a cost, the response depends on the order of the risk change. This discrepancy arises because even-order risk increases of a cost raise the riskiness of the payoff distribution, whereas odd-order risk increases of a cost reduce it. We identify the stochastic dominance orders to resolve this discrepancy and discuss specific decision problems as applications. This paper was accepted by Manel Baucells, behavioral economics and decision analysis.

Publisher

Institute for Operations Research and the Management Sciences (INFORMS)

Subject

Management Science and Operations Research,Strategy and Management

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