Utility Functions Whose Parameters Depend on Initial Wealth

16 Pages Posted: 19 Oct 2003

See all articles by Christian S. Pedersen

Christian S. Pedersen

Mercer, Oliver, Wyman and Company

Stephen E. Satchell

University of Cambridge - Faculty of Economics and Politics

Abstract

Conventional one-period utility functions in Economics assume that initial wealth only enters preferences through the definition of final wealth. Consequently, those utility functions most utilized (i.e., exponential and quadratic) have implausible risk characteristics. The authors characterize a new class of utility function whose risk parameters depend upon initial wealth and obtain several desirable results. In particular, investors with quadratic and exponential utility functions can have decreasing risk aversion, and risky assets in a quadratic utility multi-asset environment do not have to be inferior as implied by the traditional framework.

Suggested Citation

Pedersen, Christian S. and Satchell, Stephen E., Utility Functions Whose Parameters Depend on Initial Wealth. Bulletin of Economic Research, Vol. 55, pp. 357-371, October 2003. Available at SSRN: https://ssrn.com/abstract=450942

Christian S. Pedersen (Contact Author)

Mercer, Oliver, Wyman and Company ( email )

1 Neal Street
London WC2H 9QL
United Kingdom
44 20 7333 8333 (Phone)
44 20 7333 8334 (Fax)

Stephen E. Satchell

University of Cambridge - Faculty of Economics and Politics ( email )

Austin Robinson Building
Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom
44 (0)1223 335213 (Phone)
44 (0)1223 335475 (Fax)

HOME PAGE: http://www.econ.cam.ac.uk/faculty/satchell/index.h

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