ECO102H1 Lecture Notes - Lecture 22: Risk Aversion, Risk Premium, Daniel Bernoulli
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ECO102H1 Full Course Notes
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Many types of behaviour and markets are responses to uncertainty over economic outcomes: intertemporal choices (savings, consumption, investment and asset markets, human capital decisions, insurance, agriculture (especially in poor countries, strategic interaction. It is relatively straightforward to incorporate uncertainty into our models of consumer choice: expected utility theory. We describe uncertainty of outcomes using random variables: random variable have uncertain future values. Important to distinguish decisions made before known outcomes, from the outcomes (and consequences) of the realizations of the random variables: ex ante; before the fact, ex post; after the fact. Outcome of a random variable depends on the realized state of nature (possible future events) Assume that random outcome can take on several different values, depending on the realized state of nature: yi = (y1, y2, y3yk) Each outcome has an associated probability: prob(yi = y1) = p1; prob(yi = y2) = p2; . prob(yi=yk) = pk.
