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One theory for two different risk premia

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  • Gabillon, Emmanuelle

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.

Suggested Citation

  • Gabillon, Emmanuelle, 2012. "One theory for two different risk premia," Economics Letters, Elsevier, vol. 116(2), pages 157-160.
    • Handle: RePEc:eee:ecolet:v:116:y:2012:i:2:p:157-160
    DOI: 10.1016/j.econlet.2012.02.024
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    References listed on IDEAS

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    1. Milton Friedman & L. J. Savage, 1948. "The Utility Analysis of Choices Involving Risk," Journal of Political Economy, University of Chicago Press, vol. 56(4), pages 279-279.
    2. L. Eeckhoudt & C. Gollier & H. Schlesinger, 2005. "Economic and financial decisions under risk," Post-Print hal-00325882, HAL.
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    Cited by:

    1. Robert Reilly & Douglas Davis, 2015. "The effects of uncertainty on the WTA–WTP gap," Theory and Decision, Springer, vol. 78(2), pages 261-272, February.

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    More about this item

    Keywords

    Choices under uncertainty; Expected utility; Risk aversion; Risk premium;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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