Allocative downside risk aversion

Abstract

The literature on the intensity of downside risk aversion has been clear on the point that greater prudence is not equivalent to greater downside risk aversion, although the two concepts are linked. In the present paper, we present a new concept of the downside risk aversion of a decision maker, namely the fraction of a zero‐mean risk that the decision maker would optimally place on the upside. We then consider how this measure can be used to identify the intensity of downside risk aversion. Specifically, we show that greater downside risk aversion in our model can be accurately measured by a relationship that is very similar to, although somewhat stronger than, greater prudence.

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