RISK AND PROBABILITY PREMIUMS FOR CARA UTILITY FUNCTIONS

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.
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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

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