RISK AND PROBABILITY PREMIUMS FOR CARA UTILITY FUNCTIONS
By: Babcock, Bruce A.; Choi, E. Kwan; Feinerman, Eli
Babcock, Bruce A.; Choi, E. Kwan; Feinerman, Eli, RISK AND PROBABILITY PREMIUMS FOR CARA UTILITY FUNCTIONS, Journal of Agricultural and Resource Economics, Volume 18, Issue 1, July 1993, Pages 17-24
The risk premium and the probability premium are used to determine appropriate coefficients of absolute risk aversion under CARA utility. A defensible range of risk aversion coefficients is defined by the coefficients that correspond to risk premiums falling between 1 and 99% of the amount at risk or to probability premiums falling between .005 and .49 for a lottery that pays or loses a given sum. The consequences of ignoring risk premiums when selecting risk-aversion coefficients for representative decision makers are illustrated by calculation of the implied risk premium associated with the levels of absolute risk aversion assumed in six selected studies.