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.
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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