MEASURING RISK AVERSION: ALLOCATION, LEVERAGE, AND ACCUMULATION

Abstract

Abstract The risk‐asset ratio that measures Arrow‐Pratt relative risk aversion reflects a multidimensional risk behavior. The risk‐asset ratio is decomposed into the product of ratios that measure portfolio allocation between riskless and risk assets, use of financial leverage, and accumulation of wealth in marketable form. The three dimensions are less sensitive to the definition of wealth than is the composite risk‐asset ratio. Constant relative risk aversion can be characterized by offsetting changes in the three dimensions as wealth changes.