A Robust Approach to Risk Aversion

Abstract

We formalize the notion of monotonicity with respect to first-order stochastic dominance in the context of preferences defined over the set of temporal lotteries. It is shown that the only Kreps and Porteus (1978) preferences which are both stationary and monotone are Uzawa preferences and risk-sensitive preferences introduced by Hansen and Sargent (1995). We also extend our results to smooth recursive ambiguity models. Focusing on monotone preferences enables a much better understanding of the role of risk aversion. As an application, we derive new general results on the determinants of precautionary savings and asset prices in dynamic settings.

Keywords: recursive models, monotonicity, first-order stochastic dominance, temporal lotteries, risk aversion, ambiguity aversion, precautionary savings, asset pricing.

JEL Classification: D90, D81