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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
Published by: Western Agricultural Economics Association
Stable URL: http://www.jstor.org/stable/40986772
Page Count: 8
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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.
Journal of Agricultural and Resource Economics © 1993 Western Agricultural Economics Association