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One Theory For Two Risk Premia

  • Emmanuelle GABILLON (GREThA, CNRS, UMR 5113)
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    Generally, in the standard presentation of the expected utility model, the risk premium represents how much a risk-averse decision maker is ready to pay to have a risk eliminated. Here, however, we introduce a different risk premium: how much should a risk (which could be the return on a financial asset) yield to be acceptable to a risk-averse decision maker. Although our risk premium is derived from the Pratt bid price, it should not be confused with it: the Pratt bid price represents the monetary compensation of a risk. The standard risk premium refers to risk-avoidance; our risk premium, however, refers to risk-taking. We then reanalyse the main results concerning risk aversion under expected utility using this risk premium tool and deduce its main properties.

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    Paper provided by Groupe de Recherche en Economie Théorique et Appliquée in its series Cahiers du GREThA with number 2011-39.

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    Date of creation: 2011
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    Handle: RePEc:grt:wpegrt:2011-39
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    1. Milton Friedman & L. J. Savage, 1948. "The Utility Analysis of Choices Involving Risk," Journal of Political Economy, University of Chicago Press, vol. 56, pages 279.
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