ECON-200 Lecture Notes - Lecture 26: Risk Premium, Utility, Risk Neutral
18 Sep 2020
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Reducing risk diversification - putting resources into different risky situations. Negatively correlated - good results for 1 investment means bad results for another invesments not too closely correlated >> eliminates some risk investment. Dan has a wealth utility function of u = lnw. He currently has , but there"s a 1/8 chance that his car will blow up and he"ll lose . However, he could pay insurance 30 cents on the dollar to cover his potential losses. Calculates how much firm would pay for extra information/predictions for sales. Also dependent on whether firm is risk averse/neutral/loving. Risk preferences expected utility - sum of utilities of all possible incomes weighted by probability. Different expected values/risks >> depends on individual find utility/happiness obtained by risk. Risk averse - person always prefers given income compared to risky income risk >> diminishing marginal utility of income: 1st earned dollar not as attractive as 2nd. Risk-loving - prefers uncertain income to certain.
