The name is absent



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



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