Bivariate Stochastic Dominance and Substitute Risk-(In)dependent Utilities

Authors:
Michel Denuit;Louis Eeckhoudt
Affiliations:
Institut de Statistique, Biostatistique et Sciences Actuarielles, Université/ Catholique de Louvain, B-1348 Louvain-la-Neuve, Belgium;IÉ/SEG School of Management, Université/ Catholique de Lille, 59000 Lille, France/ and Center for Operations Research and Econometrics, Université/ Catholique de Louvain, B-1348 Louvai ...
Venue:
Decision Analysis
Year:
2010

Citing 7
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Abstract

In this paper, we show that, despite their rigid analytical form, substitute risk-independent utilities have a much wider applicability than expected. Our contribution extends that of Mosler (Mosler, K. C. 1984. Stochastic dominance decision rules when the attributes are utility independent. Management Sci.30(11) 1311--1322) by considering utility functions that exhibit properties beyond nonsatiation and risk aversion (e.g., prudence and temperance). By using the widespread idea of correlation aversion, substitute risk-independent utilities are shown to generate bivariate stochastic dominance. As an application, portfolios are compared to assess the possible hedging effect between two outcomes.