Risk and Probability Premiums for Cara Utility Functions

Risk and Probability Premiums for Cara Utility Functions

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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 15lb nitrous bottle 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 yuza blonde 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.