Rank-dependent utility and risk taking in complete markets

Xue Dong He*, Roy Kouwenberg, Xun Yu Zhou

*Corresponding author for this work

Research output: Contribution to journalArticleAcademicpeer-review

10 Citations (Scopus)

Abstract

Experimental studies show that people's risk preferences depend nonlinearly on probabilities, but relatively little is known about how probability weighting inuences investment decisions. In this paper we analyze the portfolio choice problem of investors who maximize rank-dependent utility in a single-period complete market. We prove that investors with a less risk averse preference relation in general choose a more risky final wealth distribution, receiving a risk premium in return for accepting conditional-mean-zero noise (more risk). We also propose a new scenario-based notion of less risk taking that can be applied when state probabilities are unknown or not agreed upon.

Original languageEnglish
Pages (from-to)214-239
Number of pages26
JournalSIAM Journal on Financial Mathematics
Volume8
Issue number1
DOIs
Publication statusPublished - 2017

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