Title: Utility Functions Whose Parameters Depend on Initial Wealth
Authors: Christian S. Pedersen  and Steve E. Satchell, University of Cambridge
Date: 1999
Status: working paper

Conventional one-period utility functions in Economics assume that initial wealth only enter preferences through the definition of final wealth.  Consequently, those utility functions most utilised (i.e. exponential and quadratic) have implausible risk characteristics.  The authors characterise a new class of utility functions whose parameters depend upon initial wealth.  Several desirable results are obtained.  In particular, investors with quadratic and exponential utility functions can have decreasing risk aversion and will increase their share of the risky asset as they get wealthier.  The authors conclude with a number of applications demonstrating the efficacy of this new class of utility functions.

Click here to access a pdf version of the paper

Back to the Decision Analysis Working Paper Index