Risk – Reward Representations of Expected Utility Theory

19 Pages Posted: 12 Jun 2014

See all articles by Eduardo Zambrano

Eduardo Zambrano

California State Polytechnic University, San Luis Obispo - Economics

Hayley Stevens

California State Polytechnic University, San Luis Obispo

Date Written: June 10, 2014

Abstract

For each individual with von Neumann and Morgernstern’s preferences and for each gamble that can take negative values yet has positive expected value we calculate separately the reservation values of the losses and of the gains of the gamble and denote those values by risk and reward, respectively. In this paper we show the connection between these numbers and the certainty equivalent of a gamble, explain how the (risk, reward) pair paints a richer picture about the risk and return characteristics of that gamble to that individual than the one obtained from the (risk premium, expected value) profile, and argue that the resulting risk measure is a more accurate measure of risk of loss than those that arise from strict considerations of first and second order stochastic dominance.

Keywords: Expected Utility Theory, Riskiness measures

JEL Classification: D81, G00, G22, G32

Suggested Citation

Zambrano, Eduardo and Stevens, Hayley, Risk – Reward Representations of Expected Utility Theory (June 10, 2014). Available at SSRN: https://ssrn.com/abstract=2448526 or http://dx.doi.org/10.2139/ssrn.2448526

Eduardo Zambrano (Contact Author)

California State Polytechnic University, San Luis Obispo - Economics ( email )

Orfalea College of Business
San Luis Obispo, CA 93407
United States
805-756-5327 (Phone)
805-756-1473 (Fax)

HOME PAGE: http://calpoly.edu/~ezambran

Hayley Stevens

California State Polytechnic University, San Luis Obispo ( email )

San Luis Obispo, CA 93407
United States

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