General equilibrium with risk loving,
Friedman-Savage and other preferences
Aloisio Araujo (IMPA)
The interactions between risk averse and risk lovers (or ambiguity lovers, Friedman-Savage and related behavior) have not yet been extensively analyzed in the general equilibrium literature due to the lack of convexity and, hence, failure or existence.
We show that the aggregate risk of wealth, as well as the dominance
of risk aversion in the economy, plays a role in the existence
This result can be extended to ambiguity in the sense of prospect
theory in the sense of Jullien and Salanié (2000).
Additionally, we study properties of the equilibrium, such as
conditions for risk sharing, decomposition of risk factor and
ambiguity factor in prices, and also the impact of regulation on
volatility, particularly for preferences with distorted
probabilities with CARA utility functions.
Our analyses suggest that regulation increases volatility for
pro-cyclical assets while reducing their utility levels; however,
risk lovers or optimists are those who incur the larger losses.