A Contextual Uncertainty Condition for Behavior Under Risk
Management Science · 1995 · Volume 41 · Issue 7
Abstract
Suppose that your choice between uncertain financial prospects is made more difficult by two independent contextual uncertainties concerning the size of your existing wealth. One contextual uncertainty has a greater spread than the other. If you could resolve one of these contextual uncertainties before making your choice, would you rather it be the larger or the smaller? In this paper we explore the intuitive notion that it ought to be more advantageous to resolve larger rather than smaller contextual uncertainties. The utility function for wealth u ( w ) = aw − be − cw ( a , b , c ≥ 0) is the only utility function that satisfies this condition and that is also increasing and risk averse at all wealth levels.
Keywords
risk aversion, value of information, utility functions, contextual uncertainty
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