FINE 4050 Lecture Notes - Lecture 7: Reservation Price, Consumption Smoothing, Risk Aversion
9 May 2016
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Document Summary
Risk: the variation in possible outcomes f an event that is subject to chance. Law of large #s can be used to estimate future losses: insurance companies use this to determine expected losses and approximate premiums to charge. Risk aversion unwillingness to accept a fair gamble (expected payoff = its cost) Risk neutral do not care about risk, care about expected value of the outcome. Risk loving like to take risks, always accept a fair gamble. Insurance is based on the premise that a large enough pool of people who face similar risk can be created so that losses incurred by a few can be spread over the entire pool. Insurance companies are immediataries who form pools of risk-adverse people with similar risk. The demand for insurance personal risks (i) risk of being sick, injured, disabled, (ii) premature death, (iii) unemployment (iv) not having enough income for retirement.
