Relative Risk Aversion

Abstract

An individual's preference for risky alternatives is influenced by the strength of preference he feels for the consequences and his attitude toward risk taking. Conventional measures of risk attitude confound these two factors. In this paper we formally separate these factors and explore how this separation might significantly enhance our understanding of decision making under risk. We introduce a new measure of risk attitude defined relative to strength of preference. This measure is based on comparing an individual's von Neumann-Morgenstern utility function to his strength of preference function. The properties of this measure of relative risk attitude are developed. The concept of relative risk attitude has several important implications. First, it provides a better description of an individual's attitude toward risk. Second, it provides a better way to combine preferences of various experts in the context of multicriteria decision making. Finally, it provides a better insight into the implications of some commonly employed preference aggregation rules in group decision making.