Definition of Arrow-Pratt Measure

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:
R_A=-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 R_A() is decreasing in c, then u() displays decreasing absolute risk aversion. If R_A() is increasing in c, then u() displays increasing absolute risk aversion. If R_A() 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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