On the theory of risk aversion and the theory of risk

Relationships between the theory of risk aversion and the theory of risk have been noted by Diamond and Stiglitz [12], Kihlstrom and Mirman [24], and Leland [29]. The main result of this paper is a characterization of the Pratt and Kihlstrom-Mirman [24, 46] relation “more risk averse” between utility functions in terms of a stochastic dominance or “riskier” relation between certain probability measures derived from these utility functions. This result is used in the comparison of risk-adjusted portfolio yields to extend to the several risky asset case the intuition provided by the Arrow-Pratt [1, 46] portfolio theorem that “more risk averse” means “will take less risk.”