Workgroup Financial Mathematics

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Higher-Order Risk Attitudes (Louis Eeckhoudt & Harris Schlesinger)


Recently, prudence, temperance and higher-order risk attitudes have been defined via preferences over particular classes of lottery pairs.  What makes these characterizations particularly appealing is their simplicity, as they are stated in terms of comparing simple 50-50 lottery pairs.  In this paper, we review some of the literature about these higher-order risk attitudes.  We show how these attitudes entail a preference for combining “good” outcomes with “bad” outcomes and discuss their relevance for non-hedging types of risk-management strategies, such as precautionary saving.  We also examine some early experimental results in this direction and some early attempts to measure the intensity of these effects.  Although higher-order attitudes are not identical to preferences over moments of a statistical distribution, they are consistent with such preferences.  Under common restrictions made in empirical analyses, moment preference is often congruent to these higher-order risk attitudes so that the analysis that we present has many implications for empirical modeling.  Since the models of higher-order risk attitudes presented here are relatively new, it is our hope that this paper will stimulate new research – both theoretical and empirical/experimental -- in this relatively nascent and potentially important topic.