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Decision Making Based on Risk-Value Tradeoffs

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This essay provides a review for measures of risk and risk-value models that we have developed for the past ten years. Risk-value models are a new class of decision making models based on the idea of risk-value tradeoffs. Intuitively, individuals may consider their choices over risky alternatives by trading off between risk and return, where return is typically measured as the mean (or expected return) and risk is measured by some indicator of dispersion or possible losses. This notion is prevalent in the literatures in finance, marketing and other areas.

Markowitz (1959, 1987, 1991) proposed variance as a measure of risk, and a mean-variance model for portfolio selection based on minimizing variance subject to a given level of mean return. But arguments have been made that mean-variance models are appropriate only if the investor's utility function is quadratic or the joint distribution of returns is normal. However, these conditions are rarely satisfied in practice.

Keywords

  • Utility Function
  • Portfolio Selection
  • Prospect Theory
  • Risk Averse
  • Utility Model

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Correspondence to James S. Dyer .

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Jia, J., Dyer, J.S. (2009). Decision Making Based on Risk-Value Tradeoffs. In: Brams, S.J., Gehrlein, W.V., Roberts, F.S. (eds) The Mathematics of Preference, Choice and Order. Studies in Choice and Welfare. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-540-79128-7_4

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