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Lecture 0525 - Lecture Risk Insurance Poverty Traps...

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Lecture: Risk, Insurance, & Poverty Traps 5/25/10 Business Today: Finish risk intro and begin insurance and poverty trap discussion o Hand in PS3 o Reading 1: “Income smoothing and consumption smoothing” o Reading 2: “Poverty traps and index based risk transfer products” Thursday: Index insurance o The logic of index insurance and an example of a research agenda o Reading: “Poverty traps and index based risk transfer products” o Receive PS4 – due next Thurs in class Sections this week o Work through examples of risk key concepts o Bring a calculator Next Tuesday (June 1): Environment and Development Next Thursday (June 3): How do we measure the impact of development programs? Final Exam: Wednesday, June 9 at 1-3 same room o Not cumulative, only on things since midterm Key Concepts: Certainty Equivalent and Risk Premium Situation: o I start out w/ initial wealth, W o I consider doing a risky activity that generates income, y y = random variable Certainty equivalent (CE): the amt of money that, if paid w/ certainty, makes me indifferent between receiving the money vs. undertaking the risky activity o CE is implicitly defined by U(W+CE)=EU(W+y) o Utility of receiving CE w/ certainty = expected value of utility if I the risky activity Risk premium (P): amt of money I am willing to pay in order to eliminate the risk associated w/ activity o P implicitly defined by: U(W+E(y) - P) = EU(W+y) o
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