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Risk and Probability Premiums for CARA Utility Functions

Bruce A. Babcock, E. Kwan Choi and Eli Feinerman
Journal of Agricultural and Resource Economics
Vol. 18, No. 1 (July 1993), pp. 17-24
Stable URL: http://www.jstor.org/stable/40986772
Page Count: 8
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Since scans are not currently available to screen readers, please contact JSTOR User Support for access. We'll provide a PDF copy for your screen reader.
Risk and Probability Premiums for CARA Utility Functions
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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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