October 28, 2004

Utility-Based Valuation of Risk

The fundamental basis for the value of risk could be curvature in agents utility functions.

If the utility of $0 is 0, then there are three basic possibilities.

PA280037a.jpg

The log function would be an interesting choice, but we will use the square root function this semester.

PA280043a.jpg

The basic diagram showing the value of the risk inherent in an asset with two possible values.

PA280039a.jpg

Posted by bparke at October 28, 2004 12:08 AM