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Statistics & Risk Modeling

with Applications in Finance and Insurance

Editor-in-Chief: Stelzer, Robert

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Risk measurement with equivalent utility principles

Michel Denuit / Jan Dhaene / Marc Goovaerts / Rob Kaas / Roger Laeven

Citation Information: Statistics & Decisions. Volume 24, Issue 1/2006, Pages 1–25, ISSN (Print) 0721-2631, DOI: 10.1524/stnd.2006.24.1.1, September 2009

Publication History

Received:
2005-12-21
Accepted:
2006-03-03
Published Online:
2009-09-25

SUMMARY

Risk measures have been studied for several decades in the actuarial literature, where they appeared under the guise of premium calculation principles. Risk measures and properties that risk measures should satisfy have recently received considerable attention in the financial mathematics literature. Mathematically, a risk measure is a mapping from a class of random variables to the real line. Economically, a risk measure should capture the preferences of the decision-maker.

This paper complements the study initiated in Denuit, Dhaene & Van Wouwe (1999) and considers several theories for decision under uncertainty: the classical expected utility paradigm, Yaari's dual approach, maximin expected utility theory, Choquet expected utility theory and Quiggin's rank-dependent utility theory. Building on the actuarial equivalent utility pricing principle, broad classes of risk measures are generated, of which most classical risk measures appear to be particular cases. This approach shows that most risk measures studied recently in the financial mathematics literature disregard the utility concept (i.e., correspond to linear utilities), restricting their applicability. Some alternatives proposed in the literature are discussed.

Key words and phrases: risk measures; theories for decision under uncertainty; axiomatic characterization; equivalent utility; risk aversion

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