Risk-value models

Abstract

In this paper we propose a risk-value model for evaluating decisions under risk. In this model preference for a gamble is determined by its riskiness and its value or worth. In a simple form of the risk-value model, risk is measured by variance and value by expected returns. We discuss several other empirically more attractive forms of the risk-value model. We show that the risk-value model provides a framework for unifying the streams of research on risk judgments and on modeling choices. We explore the consistency of the risk-value model with both expected utility and non-expected utility preferences. Specifically, we show that if we define risk and value in appropriate ways, the rank order produced by the risk-value model will be consistent with a suitably chosen expected utility or non-expected utility model. We briefly discuss application of the risk-value model to the theory of finance and to social risk analysis.