Invariant risk attitudes (Q1877159)

Risk is an important concept in economic theory. Here the authors study constant absolute risk aversion and relative risk aversion in a general random state preference model with a quasiconcave certainty equivalent function \(e\). Since both concepts are too restrictive in most cases they propose a generalization, invariant risk aversion, which retains some of the desirable features of the other concepts. With some additional assumptions they derive an explicit representation of \(e(y)\) as a function of \(E(y)\) and the risk index \(\rho (y)\). The latter is rather similar to the standard deviation in as much as it is homogeneous and translation in variant. This is then applied to portfolios with a riskless asset and the property of the two fund separation is shown. Thus the efficiency frontier describes the trade off between \(E(y)\) and risk index \(\rho (y)\) as a linear function.