Higher-order risk attitudes

Abstract

Risk aversion has long played a key role in examining decision making under uncertainty. But we now know that prudence, temperance, and other higher-order risk attitudes also play vital roles in examining such decisions. In this chapter, we examine the theory of these higher-order risk attitudes and show how they entail a preference for combining "good" outcomes with "bad" outcomes. We also show their relevance for non-hedging types of risk-management strategies, such as precautionary saving. Although higher-order attitudes are not identical to preferences over moments of a statistical distribution, we show how they are consistent with such preferences. We also discuss how higher-order risk attitudes might be applied in insurance models.