I.A.1.4.3 Risk Aversion (and Risk Tolerance)

Question 1

Concave utility function (Downward curvature)

Answer 1

If a utility function with a concave curvature then the risk attitude of the decision maker or firm is that of risk aversion.

Question 2

Risk Aversion

Answer 2

The minimum selling price of a risky opportunity is less than its expected value

Question 3

Convex Utility Function (Upward curvature)

Answer 3

If a utility function with a convex curvature then the risk attitude of the decision maker or firm is that of risk-seeking attitude

Question 4

Risk-seeking

Answer 4

A risky opportunity would be perceived as having greater expected utility than its expeceted value

Question 5

Risk-neutral

Answer 5

• No curvature, a straight line function
• The expected value of outcomes is the choice criterion.

Question 6

Local Coefficient of Risk Aversion

Answer 6

• For a concave utility function the curvature is negative b/c u’’(x) < 0

Question 7

Local Coefficient of Risk Tolerance

Answer 7

• The inverse o the Local Coefficient of Risk Aversion
• Expressed in the same monetary units as x
• λ - Lambda
• Stipulating the coefficient of risk tolerance over vaiours levels of wealth is equivalent to stipulating a utility function

Question 8

Curvature of a twice differentiable function

Answer 8

Defined as the ratio of its second order derivative to its first-order derivative