From Local Theory of Risk Aversion to an Intertemporal Theory of Risks Under Discrete Choices
While the well-known Pratt-Arrow measure of risk premium is useful in studying local risks, this paper introduces new measures to cope with non-trivial risks, including default. The premia derived are cast in terms of life-time and instantaneous utilities and required income. the results follow from the martingale property of pricing of american type contingent claims analogous to perpetual binary put options on dividend paying assets.
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