RSM332H1 Lecture Notes - Lecture 6: Risk Premium, Risk Neutral, Economic Model
Document Summary
Risk means uncertainty but investors, on average, are risk averse. A fair game is a game where expected payout equals to the cost of playing the game. If (cid:272)ost of playi(cid:374)g the ga(cid:373)e is also , the(cid:374) it"s a fai(cid:396) ga(cid:373)e. A person is said to be risk averse if the person is not willing to play the fair game. A person is said to be risk neutral if she is different between playing the game and not playing the game. A person is said to be risk seeking if the person is willing to play a fair game. In general, a risk averse person would play if p < e(r) U is discount rate for the risk only since there is no time-value of money. You use interest rate r to discount if you are a risk neutral person. Example: (1) lambda is risk (no risk as this is a tbill) (2) risky investment (high risk stock)
