Risk Premium
- The risk premium is amount of money which a risk averse person would pay to keep away from taking a risk.
* Risk Premium: A Scenario
- The person has a 5% probability of earning $30,000 and a 5% probability of earning $10,000 (expected income = $20,000).
- The expected utility of the two outcomes can be found as:
- E(u) = .5(18) + .5(10) = 14
* Question
- How much would the person pay to keep away from risk?