The Disutility of Uncertain Losses

Abstract

ABSTRACT The ancient hypothesis that equal quantities of money gained or lost may have different utilities depending upon the cirumstances of the recipient has never been fully accepted into the main body of economic theory. To eliminate confusion, it is essential to abandon the attempt to quantify a utility function of wealth or income, and to develop instead a utility function of uncertain gains and losses, basing it upon relative values placed upon alternative contingencies by the same individuals. The basic facts of life insurance and of health insurance show that the majority of persons are prepared to pay approximately twice the actuarial value to avoid major contingencies. These results allow definition of a marginal utility coefficient for this range of losses. Small losses and moderate gains apparently have utility coefficients approximating unity. A working hypothesis based upon the above is consistent with evidence as to risk aversion from the securities markets. The most important characterist...