{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

Lecture9

# Lecture9 - Lecture 9 Risk aversion risk premia insurance...

This preview shows pages 1–6. Sign up to view the full content.

Lecture 9 Risk aversion; risk premia, insurance markets

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Definitions Expected value of outcomes X = {X 1 , X 2 , …, X n } with associated probabilities p(X 1 ), … , p(X n ) is E(X) = p(X 1 )X 1 + … p(X n )X n Expected utility: E(U(X)) = p(X 1 )U(X 1 )+p(X 2 )U(X 2 )+..+ p(X n )U(X n )
Risk Aversion Income is 1 million with probability ½ and 100,000 with probability ½. Expected income = (1,000,000)(.5) + (100,000)(.5) = 550,000 Expected utility = U(1M)(.5) + U(100K)(.5) Risk aversion: utility of expected income is larger than expected utility. income Utility 1 million 100,000 550,000 U(550K) E(U(X)) = .5U(1M)+ .5U(100K) Utility of Expected income = U[(.5)(1M)+(.5)(100K)] =U(550K)

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
Risk preferences: utility for income Risk loving Risk averse Risk neutral A A A B B B
Risk Premium The risk premium measures the income a risk averse person will give up in order to replace a risky outcome with a guaranteed outcome. The extent of risk aversion depends on the curvature of the utility function, e.g., its second derivative.

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

### Page1 / 10

Lecture9 - Lecture 9 Risk aversion risk premia insurance...

This preview shows document pages 1 - 6. Sign up to view the full document.

View Full Document
Ask a homework question - tutors are online