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This book updates and advances the theory of expected utility as applied to risk analysis and financial decision making. Von Neumann and Morgenstern pioneered the use of expected utility theory in the 1940s, but most utility functions used in financial management are still relatively simplistic and assume a mean-variance world. Taking into account recent advances in the economics of risk and uncertainty, this book focuses on richer applications of expected utility in finance, macroeconomics, and environmental economics. The book covers these topics: expected utility theory and related concepts; the standard portfolio problem of choice under uncertainty involving two different assets; P the basic hyperplane separation theorem and log-supermodular functions as technical tools for solving various decision-making problems under uncertainty; s choice involving multiple risks; the Arrow-Debreu portfolio problem; consumption and saving; the equilibrium price of risk and time in an Arrow-Debreu economy; and dynamic models of decision making when a flow of information on future risks is expected over time. The book is appropriate for both students and professionals. Concepts are presented intuitively as well as formally, and the theory is balanced by empirical considerations. Each chapter concludes with a problem set.

The effects of risk and risk aversion in the single-period inventory ("newsboy") problem are examined. Comparative-static effects of changes in the various price and cost parameters are determined and related to the newsboy's risk aversion. The addition of a random background wealth and of an increase in the riskiness of newspaper demand are also examined. Although many of the comparative effects generally are ambiguous, some fairly simple restrictions on preferences and/or risk increases are shown to lead to qualitatively deterministic results.newsboy problem, inventory, increase in risk, risk aversion, prudence

By using their financial reserves efficiently, and thus smoothing shocks on asset returns, pension funds can facilitate intergenerational risk-sharing. In addition to the primary benefit it improved time diversification, this form of risk allocation affords the secondary benefit of allowing the fund to take better advantage of the equity premium, which also favors the consumers. In this paper, our aim is twofold. First, we characterize the socially efficient policy rules of a collective pension plan in terms of portfolio management, capital payments to retirees, and dividend payments to shareholders. We examine both the first-best rules and the second-best rules, where, in the latter case, the fund is constrained by a solvency ratio and by a guaranteed minimum return to workers' contributions. Second, we measure the social surplus of the system compared to a situation in which each generation would save and invest in isolation for its own retirement. One of the main results of the paper is that better intergenerational risk-sharing does not reduce the risk born by each generation. Rather, it increases the expected return to the workers' contributions.