Hyperbolic Absolute Risk

Aversion
Presented by: Nitasha Ahmed

ABSOLUTE RISK
AVERSION
With the change in amount of wealth how much
the investors preference changes (risk aversion)
The higher the curvature of u(c), the higher the
risk aversion.

 Expected utility functions are not uniquely

defined (are defined only up to affine
transformations), a measure that stays
constant with respect to these transformations .
One such measure is the Arrow Pratt measure
of absolute risk-aversion (ARA)
In geometry, an affine transformation, affine map
or an affinity (from the Latin, affinis, "connected
with") is a function between affine spaces which
preserves points, straight lines and planes.

HYPERBOLIC ABSOLUTE
RISK AVERSION
Hyperbolic absolute risk aversion is part of the
family of utility functions originally proposed by John
von Neumann and Oskar Morgenstern in the late
1940s.
Also called linear risk tolerance
It is the most general class of utility functions that
are usually used in practice (specifically, CRRA
(constant relative risk aversion), CARA (constant
absolute risk aversion), and quadratic utility all
exhibit HARA

 A utility function exhibits HARA if its absolute risk

aversion is a hyperbolic function, namely

Thus relative risk aversion is increasing ifb> 0 (for ), constant ifb= 0, and decreasing if

 If the investors prefer more to less than the utility

function will reflect their desires over the
restricted range of wealth. The most common
quadratic utility finction is

risk-aversion coefcient=

 While utility functions have been mined by economists

to derive elegant and powerful models, there are
niggling details about them that should give us pause.
The first is that no single utility function seems to fit
aggregate human behavior very well.
The second is that the utility functions that are easiest
to work with, such as the quadratic utility functions,
yield profoundly counter intuitive predictions about how
humans will react to risk.
The third is that there are such wide differences across
individuals when it comes to risk aversion that finding a
utility function to fit the representative investor or
individual seems like an exercise in futility.
Notwithstanding these limitations, a working knowledge
of the basics of utility theory is a prerequisite for
sensible risk management.

Examples
Investment in saving and retirement funds, stocks, insurance.
Static portfolios
If all investors have HARA utility functions with the same
exponent, then in the presence of a risk-free asset a two-fund
monetary separation theorem results. Every investor holds
the available risky assets in the same proportions as do all
other investors, and investors differ from each other in their
portfolio behavior only with regard to the fraction of their
portfolios held in the risk-free asset rather than in the
collection of risky assets.
Moreover, if an investor has a HARA utility function and a riskfree asset is available, then the investor's demands for the
risk-free asset and all risky assets are linear in initial wealth.