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Risk And Probability Premiums For Cara Utility Functions

Author

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  • Babcock, Bruce A.
  • Choi, E. Kwan
  • Feinerman, Eli

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.

Suggested Citation

  • Babcock, Bruce A. & Choi, E. Kwan & Feinerman, Eli, 1993. "Risk And Probability Premiums For Cara Utility Functions," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 18(1), pages 1-8, July.
    • Handle: RePEc:ags:jlaare:30810
    DOI: 10.22004/ag.econ.30810
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    References listed on IDEAS

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