Pareto utility |
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Authors: | Masako Ikefuji Roger J. A. Laeven Jan R. Magnus Chris Muris |
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Affiliation: | 1. Institute of Social and Economic Research, Osaka University, Osaka, Japan 2. Department of Environmental and Business Economics, University of Southern Denmark, Esbjerg, Denmark 3. Department of Econometrics & Operations Research, Tilburg University, Tilburg, The Netherlands 4. Department of Economics, Simon Fraser University, Burnaby, BC, Canada
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Abstract: | In searching for an appropriate utility function in the expected utility framework, we formulate four properties that we want the utility function to satisfy. We conduct a search for such a function, and we identify Pareto utility as a function satisfying all four desired properties. Pareto utility is a flexible yet simple and parsimonious two-parameter family. It exhibits decreasing absolute risk aversion and increasing but bounded relative risk aversion. It is applicable irrespective of the probability distribution relevant to the prospect to be evaluated. Pareto utility is therefore particularly suited for catastrophic risk analysis. A new and related class of generalized exponential (gexpo) utility functions is also studied. This class is particularly relevant in situations where absolute risk tolerance is thought to be concave rather than linear. |
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