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One theory for two different risk premia

Authors
Journal
Economics Letters
0165-1765
Publisher
Elsevier
Volume
116
Issue
2
Identifiers
DOI: 10.1016/j.econlet.2012.02.024
Keywords
  • Choices Under Uncertainty
  • Expected Utility
  • Risk Aversion
  • Risk Premium
Disciplines
  • Economics

Abstract

Abstract 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 reanalyze the main results concerning risk aversion under expected utility using this risk premium tool and deduce its main properties.

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