Outside Risk Aversion and the Comparative Statics of Increasing Risk in Quasi-Linear Decision Models

Abstract

Necessary and sufficient conditions are derived to determine the effect of increases in Rothschild-Stiglitz risk on optimal decisions in a class of competitive models with price uncertainty. Outside risk aversion and composite outside risk aversion are defined. The effect of increased risk on the optimal decision is controlled by composite outside risk aversion. It is decomposed into a wealth effect, controlled by downside risk aversion, and an uncertainty effect, controlled by outside risk aversion. Composite outside risk aversion is shown to be equivalent to outside risk aversion, so that the uncertainty effect controls the overall effect. Copyright 1995 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

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