The risk premium and the effects of risk on utility

Abstract

This work shows that the risk premium can be a mistaken measure of the reduction in utility caused by uncertainty since, when different level of wealth are considered, the relative size of the former is related to that of the latter only in some cases. The analysis indicates that this is because the size of the risk premium depends both on the size of the disutility of risk and on the size of the marginal utility of money. Some simple economic problems where this conclusion is relevant are also examined.

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