Risk and Probability Premiums for CARA Utility Functions

Date
1993-07-01
Authors
Babcock, Bruce
Babcock, Bruce
Choi, E. Kwan
Choi, E. Kwan
Feinerman, Eli
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Economics
Abstract

The risk premium and the probability premium are used to determine appropriate coefficients of absolute risk aversion under CARA utility. A defensible range of risk-aversion coefficients is defined by the coefficients that correspond to risk premiums falling between 1 and 99% of the amount at risk or to probability premiums falling between .005 and ,49 for a lottery that pays or loses a given sum. The consequences of ignoring risk premiums when selecting risk-aversion coefficients for representative decision makers are illustrated by calculation of the implied risk premium associated with the levels of absolute risk aversion assumed in six selected studies.

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This is an article from Journal of Agricultural and Resource Economics, 18(1) 1993; 17-24. Posted with permission.

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