Article ID | Journal | Published Year | Pages | File Type |
---|---|---|---|---|
5076223 | Insurance: Mathematics and Economics | 2016 | 12 Pages |
Abstract
This paper develops a stochastic dominance rule for the reference-dependent utility theory proposed by KÅszegi and Rabin (2007). The new ordering captures the effects of loss aversion and can be used as a semi-parametric approach in the comparison of risks with reference points. It is analytically amenable and possesses a variety of intuitively appealing properties, including the abilities to identify both “increase in risk” and “increase in downside risk”, to resolve the Allais-type anomalies, to capture the violation of translational invariance and scaling invariance, and to accommodate the endowment effect for risk. The generalization to third-order dominance reveals that loss aversion can either reinforce or weaken prudence, depending on the location of the reference point. Potential applications of the new ordering in financial contexts are briefly discussed.
Related Topics
Physical Sciences and Engineering
Mathematics
Statistics and Probability
Authors
Dongmei Guo, Yi Hu, Shouyang Wang, Lin Zhao,