Incremental Risk Vulnerability
13
(10)
so that
q 1∣∆( y 1)| = q 2∆( y 2)
Now r(w) can be rewritten from (6) as
^( w )
E ʃ u'(W) -u"(W)
y ∣Ey[u'(W)] u'(W)
Ey {Eu-WWÎr ( w ’}
Hence, ^(w) is the expected value of the coefficient of absolute risk aversion, using the
risk-neutral probabilities given by the respective probabilities multiplied by the ratio of
the marginal utility to the expected marginal utility. Thus, r(w) is a convex combination
of the coefficients of absolute risk aversion at the different values of y . For the three-
point distribution being considered, ^(w) is a convex combination of r(W0), r(W1), and
r(W2). Suppose that y0 = 0. Then q0 → 1 is feasible. Hence, as q0 → 1, ^(w) → r(W0).
Therefore, in condition (9) we replace ^(w) by r(W0). Since W0 can take any value in
the range [W1,W2], f (w, y, s) must have the required sign for every value of r(W0), where
W1 ≤ W0 ≤ W2. Thus, since q1 ∣∆(y1)∣ > 0, the condition as stated in Proposition 1 must
hold. As y ∈ (y, y), W2 - W1 < y - y.
Sufficiency
To establish sufficiency we use a method similar to that used by Pratt and Zeckhauser
(1987) and Gollier and Pratt (1996).
a) We first show
u'"(W2) - u"'(W1) < -r(W) [u"(W2) - u11(W1)] , ∀ W1 ≤ W ≤ W2
=⇒ f (w, y, s) > 0, ∀ (w, y, s)
We need to show that f (w, y, s) > 0, for all non-degenerate probability distributions of y.
Hence, we need to prove that the minimum value of f (w, y, s) over all possible probability
distributions {qi}, with E(∆(y)) = 0, must be positive. In a manner similar to Gollier
and Pratt (1996), this can be formulated as a mathematical programming problem, where
f (w, y, s) is minimized, subject to the constraints that all qi are non-negative and sum
More intriguing information
1. Disturbing the fiscal theory of the price level: Can it fit the eu-15?2. The name is absent
3. Magnetic Resonance Imaging in patients with ICDs and Pacemakers
4. The name is absent
5. The name is absent
6. AN ANALYTICAL METHOD TO CALCULATE THE ERGODIC AND DIFFERENCE MATRICES OF THE DISCOUNTED MARKOV DECISION PROCESSES
7. The name is absent
8. Motivations, Values and Emotions: Three Sides of the same Coin
9. The name is absent
10. The name is absent