Risk and Probability Premiums for Cara Utility Functions

The risk premium and the probability premium are used to determine appropriate coefficients of absolute risk aversion under CARA utility.A defensible diwan/sette range of risk aversion coefficients is defined by the coefficients that correspond to risk premiums falling between 1 and 99% of the amount at risk or to probability premiums falling between.005 and.49 for a lottery that pays or loses a given sum.

The consequences of ignoring risk premiums when selecting risk-aversion coefficients for representative decision makers are illustrated by calculation of the implied risk premium associated Pin with the levels of absolute risk aversion assumed in six selected studies.

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