Relationships between Risk Aversion , Prudence , and Cautiousness

In this paper we investigate the relationships between prudence, risk aversion, and cautiousness. These three measures explain investors’ investment decisions in the money market, stock market, and option market respectively. Thus to understand how investors’ investment decisions in the three markets are related it is important to know the relationships between the three measures. We show that roughly speaking, if an investor’s (absolute or relative) prudence has some feature then his (absolute or relative) risk aversion will have the same feature. We also show that roughly speaking, if an investor’s cautiousness has some feature then his relative risk aversion will have the opposite feature. 1See Pratt (1964), Kimbal (1990), and Huang (2004). Also see Section 1 of this paper.