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Risk measures and theories of choice

Tsanakas, A. and Desli, E. (2003). Risk measures and theories of choice. British Actuarial Journal, 9(4), pp. 959-991. doi: 10.1017/S1357321700004414

Abstract

We discuss classes of risk measures in terms both of their axiomatic definitions and of the economic theories of choice that they can be derived from. More specifically, expected utility theory gives rise to the exponential premium principle, proposed by Gerber (1974), Dhaene et al. (2003), whereas Yaari's (1987) dual theory of choice under risk can be viewed as the source of the distortion premium principle (Denneberg, 1990; Wang, 1996). We argue that the properties of the exponential and distortion premium principles are complementary, without either of the two performing completely satisfactorily as a risk measure. Using generalised expected utility theory (Quiggin, 1993), we derive a new risk measure, which we call the distortion-exponential principle. This risk measure satisfies the axioms of convex measures of risk, proposed by Föllmer & Shied (2002a,b), and its properties lie between those of the exponential and distortion principles, which can be obtained as special cases.

Publication Type: Article
Publisher Keywords: Risk Measures; Premium Calculation Principles; Coherent Measures of Risk; Distortion Premium Principle; Exponential Premium Principle; Expected Utility; Dual Theory of Choice Under Risk; Generalised Expected Utility
Subjects: H Social Sciences > HF Commerce
Departments: Cass Business School > Actuarial Science & Insurance
URI: http://openaccess.city.ac.uk/id/eprint/5989
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