The Behavioural Components of Risk Aversion

Abstract

The risk premium is affected by loss aversion and probability distortions as well as utility curvature. We introduce two variants - the total risk premium relative to objective expected value, and the subjective risk premium relative to perceived expected value. Approximate solutions for each provide analogies to the Pratt-Arrow coefficient of risk aversion (showing how risk attitude depends on each behavioural component), and sufficient conditions for risk aversion. Earlier results of Levy and Levy (2002) which examined decision weights in isolation are revised and extended to show how the curvature and loss aversion conditions are affected by probabilitydistortions