ECO200Y1 Lecture Notes - Lecture 12: Risk Premium, Moral Hazard, Market Failure
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ECO200Y1 Full Course Notes
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Applications of the expected utility approach to choice under uncertainty. Source: bb, chapter 15, sections 15. 3 15. 4 (exclude value of information) and lecture. We know that a risk averse person will not take a fair bet. Put another way: for a risk averse person u(ev) > pi*u(oi) where p stands for probability and o stands for (dollar value of) outcome. In other words, the individual prefers certainty over a bet that has the same expected. Or, the individual would not be willing to pay the ev as the price or entry fee to make the bet. Then, at some lower level of the fee (f), a risk averse person would be indifferent between taking the bet and not taking the bet. The difference between that fee and the expected value is called the risk premium (rp). Here are two risky propositions facing a risk averse person with our traditional.
