--%>
Assignment Help - homework help

Certainty equivalent as function of risk-aversion parameter

Explain Certainty equivalent as a function of the risk-aversion parameter.

E

Expert

Verified

When the wealth is random, and all outcomes can be assigned a probability, one can ask what amount of certain wealth has the same utility as the expected utility of the unknown outcomes. Simply solve

U(Wc) = E[U(W)].

The quantity of wealth Wc that solves this equation is called the certainty equivalent wealth. One is therefore indifferent between the average of the utilities of the random outcomes and the guaranteed amount Wc. As an example, consider the

2337_Certainty equivalent as a function of the risk-aversion parameter.png

Figure: Certainty equivalent as a function of the risk-aversion parameter

Figure demonstrates a plot of the certainty equivalent for example like a function of the risk-aversion parameter η. See how it decreases the greater the risk aversion.

   Related Questions in Financial Management

  • Q : How two stocks fully correlated over

    How two stocks fully correlated over short timescales?

    		•
  • Q : Explain statistical modelling way of

    Explain statistical modelling way of determine the model.

    		•
  • Q : Dfd A bank sells a $3,000,000 FRA for a

    A bank sells a $3,000,000 FRA for a three-month period beginning three months from today and ending six months from today. The purpose of the FRA is to cover the interest rate risk caused by the maturity mismatch from having made a three-month Eurodollar loan and having accepted a six-month Eurodol

    		•
  • Q : Explain the denotation a utility

    Explain the denotation a utility function and how it can vary between investors?

    		•
  • Q : Describe balance of payments identity

    Describe balance of payments identity and explain its implication under the fixed & flexible exchange rate regimes.The balance of payments identity holds that the combined balance on the current & capital accounts have to be equivalent i

    		•
  • Q : How is quantity of model risk

    How is quantity of model risk dependency on vega hedge?

    		•
  • Q : Interest payments between

    Create a different arrangement of interest payments between the counterparties and the swap bank that yet leaves each counterparty along with an all-in cost 1/2 percent below each's best rate & the swap bank with a 1/4 percent inflow.Company

    		•
  • Q : Describe condition for

    Describe necessary condition for a fixed-for-floating interest rate swap to be possible?For fixed-for-floating interest rate swap to be possible it is essential for a quality spread differential to be present. Generally, the default-risk premiu

    		•
  • Q : Where can be Platinum Hedging Applied

    Where can be Platinum Hedging Applied?

    		•
  • Q : What is deterministic spot rate function

    What is deterministic spot rate function?

    		•