Abstract:

Classically, risk aversion is equated with concavity of the utility function. In this work we explore the conceptual foundations of this definition. In accordance with neo-classical economics, we seek an ordinal definition, based on the decisions maker s preference order, independent of numerical values. We present two such definitions, based on simple, conceptually appealing interpretations of the notion of risk-aversion. We then show that when cast in quantitative form these ordinal definitions coincide with the classical Arrow-Pratt definition (once the latter is defined with respect to the appropriate units), thus providing a conceptual foundation for the classical definition. The implications of the theory are discussed, including, in particular, to the understanding of insurance. The entire study is within the expected utility framework.

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