UTILITY INDIFFERENCE PRICING AND MEAN-VARIANCE APPROACH WHEN THE DEGREE OF RISK AVERSION IS SMALL

Abstract

We study the properties of the risk-sensitive value measure and mean-variance approach studied by Hodoshima et al. [2] when the degree of risk aversion is small. We show that the two value measures work similarly in normal mixture distributions as well as any distribution when the degree of risk aversion is small. Therefore, the advantage of the risk-sensitive value measure disappears compared to mean- variance approach in any distribution when the degree of risk aversion is small. We obtain the result by approximating the risk-sensitive value measure by Taylor series expansion.