Pareto utility

Masako Ikefuji, Roger J A Laeven*, Jan R. Magnus, Chris Muris

*Corresponding author for this work

Research output: Contribution to journalArticle (Academic Journal)peer-review

10 Citations (Scopus)

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.

Original languageEnglish
Pages (from-to)43-57
Number of pages15
JournalTheory and Decision
Volume75
Issue number1
DOIs
Publication statusPublished - 1 Jul 2013

Keywords

  • Exponential utility
  • Hyperbolic absolute risk aversion (HARA)
  • Parametric utility
  • Power utility

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