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RISK AND PROBABILITY PREMIUMS FOR CARA UTILITY FUNCTIONS

173 citations0/0 files storedRePEc: Research Papers in Economics

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Decision-Making and Behavioral Economics Financial Literacy, Pension, Retirement Analysis Economic and Environmental Valuation

Abstract

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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1972Essays in the Theory of Risk-Bearing.1980Attitudes Toward Risk: Experimental Measurement in Rural India

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