Changes in Risky Benefits and in Risky Costs: A Question of the Right Order

We organize and extend findings on the comparative static effects of risk changes on optimal behavior in a unifying expected utility model. We determine restrictions on preferences for clear-cut results. Risk increases of a benefit are compensated by lowering exposure to risk. For risk increases of a cost, the response depends on the order of the risk change. This discrepancy arises because even-order risk increases of a cost raise the riskiness of the payoff distribution, whereas odd-order risk increases of a cost reduce it. We identify the stochastic dominance orders to resolve this discrepancy and discuss specific decision problems as applications.

Automated summary

In this study, we organize and extend findings on the comparative static effects of risk changes on optimal behavior in a unifying expected utility model. We determine restrictions on preferences for clear-cut results. It is found that risk increases of a benefit can be compensated by lowering exposure to risk, while for risk increases of a cost, the response depends on the order of the risk change.