Modeling Non-Monotone Risk Aversion Using SAHARA Utility Functions
University of Ulm - Department of Mathematics and Economics
Maastricht University; Netspar
University of Twente - Department of Applied Mathematics
May 1, 2011
Journal of Economic Theory, Vol. 146, 2011
We develop a new class of utility functions, SAHARA utility, with the distinguishing feature that it allows absolute risk aversion to be non-monotone and implements the assumption that agents may become less risk-averse for very low values of wealth. The class contains the well-known exponential and power utility functions as limiting cases. We investigate the optimal investment problem under SAHARA utility and derive the optimal strategies in an explicit form using dual optimization methods. We also show how SAHARA utility functions extend the class of contingent claims that can be valued using indifference pricing in incomplete markets.
Number of Pages in PDF File: 26
Keywords: SAHARA utility, optimal investment problem, dual approach, utility indifference
JEL Classification: G11, G13, G22, D52, C61Accepted Paper Series
Date posted: July 1, 2011 ; Last revised: September 8, 2011
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