Question

The idea of dominance criteria and risk aversion come together in an interesting way leading to a different kind of dominance. If two risky gambles have the same expected payoff, on what basis might a risk-averse individual choose between them without performing a complete utility analysis?

Answer 1

Individual’s choice toward risk differs to a great extent for instance those who seek to lessen risk are called risk averter whereas people who prefer risk are called risk seekers however it’s noteworthy to remember that these diverse kind of risk preferences to a great extent depends on an individual’s marginal utility income whether it has increased, decreased or has remained constant.

Thus for a risk averter individual marginal utility of income reduces as he has more money and for a risk-seeker marginal utility of income enhances as his money augments however people do differ to a great extent in their attitude and behavior towards risk.

In Bernoulli’s hypothesis it’s been observed that an individual whose marginal utility of income decreases will however not accept a reasonable gamble where the anticipated value of income from a gamble is equal to income with certainty thus the individual who refuses to a fair bet is said to be risk averse.

Whereas as risk averter will prefer a given income with certainty to a risky gamble with an identical expected value of income thus it’s been firmly believed that risk aversion is been considered as the most widespread approach towards risk because of the attitude of risk aversion individuals ensures to avert various kind of risk associated with uncertainty as he entails towards a steady and a certainty in income.

However attitude of risk aversion can be further elucidated with Neumann-Morgenstern method of measuring expected utility however it’s noteworthy to acknowledge the matter of fact that marginal utility of income of a risk-averter reduces as his earnings enhances.