BU353 Chapter Notes - Chapter 2: Risk Premium, Risk Neutral, Risk Aversion
Document Summary
Someone who is risk neutral cares only about expected wealth and would not require a risk premium to accept risk. Due to risk aversion, most people are willing to pay insurance premiums in excess of their expected losses for insurance; they are willing to pay a risk premium and most require additional compensation to induce them to accept risk. The increase in wealth if a loss occurs can be viewed as the benefit of insurance, and the reduction in wealth if a loss does not occur can be viewed as the cost of insurance. Although risk-averse people generally desire insurance, the extent to which they will purchase insurance depends on the policy"s premium loading. The premium on an insurance policy = expected claim costs plus what is referred to as a loading for administrative and capital costs. If the loading = 0, then purchasing insurance does not change a person"s expected wealth.
