Louis Eeckhoudt, Harris Schlesinger, Ilia Tsetlin
Consider a simple two-state risk with equal probabilities for the two states. In particular, assume that the random wealth variable over(X, ̃)i dominates over(Y, ̃)i via ith-order stochastic dominance for i = M, N. We show that the 50-50 lottery [over(X, ̃)N + over(Y, ̃)M, over(Y, ̃)N + over(X, ̃)M] dominates the lottery [over(X, ̃)N + over(X, ̃)M, over(Y, ̃)N + over(Y, ̃)M] via (N + M)th-order stochastic dominance. The basic idea is that a decision maker exhibiting (N + M)th-order stochastic dominance preference will allocate the state-contingent lotteries in such a way as not to group the two "bad" lotteries in the same state, where "bad" is defined via ith-order stochastic dominance. In this way, we can extend and generalize existing results about risk attitudes. This lottery preference includes behavior exhibiting higher-order risk effects, such as precautionary effects and tempering effects. © 2008 Elsevier Inc. All rights reserved.
IESEG, 59000 Lille, 3 rue de la Digue, France; CORE, 1348 Louvain-la-Neuve, 34 Voie du Roman Pays, Belgium; Department of Finance, University of Alabama, Tuscaloosa, AL 35487-0224, United States; INSEAD, 77305 Fontainebleau, Boulevard de Constance, France; INSEAD, 138676, 1 Ayer Rajah Ave, Singapore
