Theory and Decision

, Volume 75, Issue 1, pp 43–57 | Cite as

Pareto utility

  • Masako Ikefuji
  • Roger J. A. Laeven
  • Jan R. Magnus
  • Chris Muris
Open Access
Article

Abstract

In searching for an appropriate utility function in the expected utility framework, we formulate four properties that we want the utility function to satisfy. We conduct a search for such a function, and we identify Pareto utility as a function satisfying all four desired properties. Pareto utility is a flexible yet simple and parsimonious two-parameter family. It exhibits decreasing absolute risk aversion and increasing but bounded relative risk aversion. It is applicable irrespective of the probability distribution relevant to the prospect to be evaluated. Pareto utility is therefore particularly suited for catastrophic risk analysis. A new and related class of generalized exponential (gexpo) utility functions is also studied. This class is particularly relevant in situations where absolute risk tolerance is thought to be concave rather than linear.

Keywords

Parametric utility Hyperbolic absolute risk aversion (HARA) Exponential utility Power utility 

JEL Classification

D81 

Notes

Acknowledgments

We are grateful to Sjak Smulders and Peter Wakker for helpful discussions, and to the referee for constructive comments. This research was funded in part by the JSPS under grant C-22530177 (Ikefuji) and by the NWO under grant Vidi-2009 (Laeven). An earlier version of this article was circulated under the title ‘Burr utility’.

Open Access

This article is distributed under the terms of the Creative Commons Attribution License which permits any use, distribution, and reproduction in any medium, provided the original author(s) and the source are credited.

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Copyright information

© The Author(s) 2012

Authors and Affiliations

  • Masako Ikefuji
    • 1
    • 2
  • Roger J. A. Laeven
    • 3
  • Jan R. Magnus
    • 3
  • Chris Muris
    • 4
  1. 1.Institute of Social and Economic ResearchOsaka UniversityOsakaJapan
  2. 2.Department of Environmental and Business EconomicsUniversity of Southern DenmarkEsbjergDenmark
  3. 3.Department of Econometrics & Operations ResearchTilburg UniversityTilburgThe Netherlands
  4. 4.Department of EconomicsSimon Fraser UniversityBurnabyCanada

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