Risk aversion is a key element of utility maximizing hedge strategies; however, it has typically been assigned an arbitrary value in the literature. This paper instead applies a GARCH-in-Mean (GARCH-M) model to estimate a time-varying measure of risk aversion that is based on the observed risk preferences of energy hedging market participants. The resulting estimates are applied to derive expli...

We formulate and carry out an analytical treatment of a single-period portfolio choice model featuring a reference point in wealth, S-shaped utility (value) functions with loss aversion, and probability weighting under Kahneman and Tversky’s cumulative prospect theory (CPT). We introduce a new measure of loss aversion for large payoffs, called the large-loss aversion degree (LLAD), and show tha...

This paper formulates a single-period portfolio choice model under Kahneman and Tversky’s cumulative prospect theory, featuring a reference point in wealth, S-shaped utility (value) functions with loss aversion, and distortions in probability. An analytical treatment of the model is carried out. A new measure of loss aversion for large payoffs, called the loss aversion degree (LAD), is introduc...

Classically, risk aversion is equated with concavity of the utility function. In this paper we explore the conceptual foundations of this definition. In accordance with neo-classical economics, we seek a scale-free definition of risk aversion, based on the decisions maker’s preference order alone, independent of numerical values. We explore two such definitions. We then show that when cast in q...

The classic definition of risk aversion, which equates risk aversion with concavity of the utility function, is inherently scale-dependent, in the sense that it is not preserved under monotone (non-linear) transformations of underlying scale, most commonly taken to be money. This limits the notion to monetary, or liquid, goods. We introduce an axiomatic definition of risk aversion, based on the...

This paper presents a context-dependent theory of decision under risk. The relevant contextual factor is the presence of a riskless lottery in a preference comparison. The theory only deviates from expected utility if the set of options contains both riskless and risky lotteries. The main motivation for the theory is to explain the gambling effect. Contrary to previous theories of the gambling ...

Experimental studies of search behavior suggest that individuals stop searching earlier than predicted by the optimal, risk-neutral stopping rule. Such behavior could be generated by two different classes of decision rules: rules that are optimal conditional on utility functions departing from risk neutrality, or heuristics derived from limited cognitive processing capacities and satisficing. T...

Experimental studies of search behavior suggest that individuals stop searching earlier than predicted by the optimal, risk-neutral stopping rule. Such behavior could be generated by two different classes of decision rules: rules that are optimal conditional on utility functions departing from risk neutrality, or heuristics derived from limited cognitive processing capacities and satisficing. T...