November 04, 2004
Risk: Statitistics vs. Utility
We spent a few days (!) comparing the standard deviation/variance view of risk with the utility-based valuation of risk. The figures are based on the table in the handout.
A closely related question is how much an agent will pay for insurance. The "insurance outcome" is less than the expected dollar outcome, but more than the value to the agent of the risky asset. Insurance companies can offer this deal because, by insuring a large number of agents, the insurance premium (the good outcome minus the insurance outcome) is greater than the good outcome minus the expected dollars.
