Risk aversion

Risk aversion is a concept in psychology, economics and finance theory explaining the behaviour of consumers and investors under uncertainty. Risk aversion occurs when a person is willing to accept a lower expected payoff if it means they can have a more predictable outcome. For a more general discussion see the main article risk.

Utility of money

In utility theory, a consumer has a utility function U(x_i) where x_i are amounts of goods with index i. From this, it is possible to derive a function u(c), of utility of consumption c as a whole. Here, consumption c is equivalent to money in real terms, i.e. without inflation. The utility function u(c) is defined only modulo linear transformation.

Related Topics:
Utility - Money - Inflation

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The graph shows this situation for the risk-averse player: The utility of the bet, E(u)=(u(0)+u(100))/2 is as big as that of the certainty equivalence, CE. The risk premium is ($50-$40)/$40 or 25%.

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