Risk aversion with nothing to lose
Year: 2024
Type: article
Abstract: In a continuous-time model, a risk-neutral decision-maker chooses the volatility of a state variable and is terminated when the variable falls below a threshold. I provide economically interpretable conditions under which the decision-maker becomes risk averse endogenously and minimizes volatility near termination, even if she faces myopic incentives to gamble for resurrection. The conditions introduce forward-looking incentives to preserve economic rents. I show these conditions are met in a wide range of apparently unrelated models, thus identifying forward-looking rents as a unifying economic mechanism behind endogenous risk aversion. I also provide conditions for the decision-maker to become risk loving endogenously.
Source: Journal of Economic Theory
Author: Stefano Pegoraro
Institution: University of Notre Dame
Language: English
Subfield: General Decision Sciences
Field: Decision Sciences
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W4402050171