It is sometimes important to know how averse to risk a certain individual is. To this effect there are a set of tools to measure risk in a quantitative way. The most common and frequently used measure of risk aversion are the Arrow-Pratt measures of absolute and relative risk-aversion. Named after John W. Pratt’s paper “Risk Aversion in the Small and in the Large”, 1964, and Kenneth Arrow’s “The Theory of Risk Aversion”, 1965, these are the measures:
Arrow-Pratt measure of absolute risk aversion:
Arrow-Pratt measure of relative risk aversion:
Where x is the payoff of a given lottery and U(x) the utility derived from that payoff.