Properties of the utility function: A market-based analysis

Doron Kliger, Ori Levy

Research output: Contribution to journalArticlepeer-review

Abstract

Using US market data, this paper sheds new empirical light on properties of the utility function. In particular, employing theoretical relations between Stochastic Discount Factors, state prices, and state probabilities, we are successful in recovering the following four functions: (i) Absolute Risk Aversion (ARA); (ii) Absolute Risk Tolerance (ART); (iii) Absolute Prudence (AP); and (iv) Absolute Temperance (AT). Our statistical analysis points out, unequivocally, that the ARA function is decreasing and convex, the ART function is convex, AT is greater than ARA, and the AP function is not decreasing. These empirical results are analyzed in light of established theory concerning, inter-alia, precautionary saving and prudence as well as the way risk attitudes are affected by the presence of "background risks" and by investors' investment horizon.

Original languageEnglish
Pages (from-to)495-508
Number of pages14
JournalJournal of Economics and Business
Volume61
Issue number6
DOIs
StatePublished - Nov 2009

Keywords

  • Market data
  • Prudence
  • Risk aversion
  • Risk tolerance
  • Temperance

ASJC Scopus subject areas

  • General Business, Management and Accounting
  • Economics and Econometrics

Fingerprint

Dive into the research topics of 'Properties of the utility function: A market-based analysis'. Together they form a unique fingerprint.

Cite this