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Definition of Arrow-Pratt Measure

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Definition: The Arrow-Pratt measure is an attribute of a utility function.

Denote a utility function by u(c). The Arrow-Pratt measure of absolute risk aversion is defined by:
RA=-u''(c)/u'(c)

This is a measure of the curvature of the utility function. This measure is invariant to affine transformation of the utility function, which is a useful attributed because such transformation do not affect the preferences expressed by u().

If RA() is decreasing in c, then u() displays decreasing absolute risk aversion. If RA() is increasing in c, then u() displays increasing absolute risk aversion. If RA() is constant with respect to changes in c, then u() displays constant absolute risk aversion.(Econterms)

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Books on Arrow-Pratt Measure:

  • Huang, Chi-fu, and Robert H. Litzenberger. 1988. Foundations of Financial Economics. Prentice-Hall, Inc.
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