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Absolute/Relative risk aversion and decreasing wealth

T

Thabo Motaung

Keen member
Good day

If an investor exhibits increasing absolute/relative risk aversion what is their attitude on purchasing risky assets if they are experiencing a decrease in their wealth? Will they be more risk averse and purchase less risky assets with their decreasing wealth?

Kind regards
 
Increasing absolute risk aversion means that investors are more risk averse about an absolute amount of money as they get wealthier. So, a decrease in wealth would mean that they are less risk averse about investing an absolute amount of money (£100 say) in risky assets. This would be almost certainly a contradiction of what is observed in reality, where we expect decreasing ARA.

Increasing relative risk aversion means that investors are more risk averse about a percentage of their wealth as they get wealthier. So, a decrease in wealth would see them become less risk averse about investing a % of their wealth in risky assets. This could be observed in reality. For example, if I only had £100, I might not care if I lost £10 because "it's only £10", but if I had £10 million I would still be very cautious about losing £1 million because it's such a lot of money - this view of the world would be consistent with increasing RRA

Good luck!
John
 
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