Decreasing Relative Risk Premium

Frank Hansen 1 , 1
  • 1 University of Copenhagen, frank.hansen@econ.ku.dk

We consider the risk premium demanded by a decision maker in order to be indifferent between obtaining a new level of wealth with certainty, or to participate in a lottery which either results in unchanged wealth or an even higher level than what can be obtained with certainty. We study preferences such that the corresponding relative risk premium is a decreasing function of present wealth, and we determine the set of associated utility functions. We find a new characterization of risk vulnerability and determine a large set of utility functions, closed under summation and composition, which are both risk vulnerable and have decreasing relative risk premium. We finally introduce the notion of partial risk neutral preferences on binary lotteries and show that partial risk neutrality is equivalent to preferences with decreasing relative risk premium.

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The B.E. Journal of Theoretical Economics (BEJTE) is a leading venue for top-notch economic theory, both pure and applied. Topics include contract theory, decision theory, game theory, general equilibrium theory, and mechanism design both pure and applied to such areas as industrial organization, public finance, labor and law and economics.

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