Which of the following statements is correct for a decision maker facing a choice between a sure thing and a lottery when the sure thing has the expected payoff of the lottery?
A)Risk-loving decision makers will require a positive risk premium to bear risk.
B)Risk-neutral decision makers will require a positive risk premium to bear risk.
C)Risk-averse decision makers will require a positive risk premium to bear risk.
D)The risk premium depends on the characteristics of the lottery, not on the characteristics of the utility function of the decision maker.

Question

Quizplus · Accepted Answer

Risk-averse decision makers require a positive risk premium to bear risk because they are more concerned about potential losses than potential gains. They will only take on risk if they expect to be compensated for it with a higher expected payoff than the sure thing. Risk-loving decision makers, on the other hand, are willing to bear risk without a positive risk premium because they are more focused on the potential gains rather than potential losses. Risk-neutral decision makers do not have a preference between risk and certainty and will only require a risk premium if the expected payoff of the lottery is lower than the expected payoff of the sure thing. The characteristics of the lottery can affect the size of the risk premium, but ultimately it is the individual decision maker's utility function that determines their preference for risk. Risk-averse decision makers are those who prefer a certain payoff over the uncertain outcome of a lottery with the same expected payoff. Therefore, they would require a positive risk premium to bear risk. Risk-loving and risk-neutral decision makers may not require a risk premium, or may even be willing to pay a premium for the opportunity to take on risk. The risk premium may depend on the characteristics of the lottery, but it is ultimately determined by the decision maker's preference for risk.

Which of the Following Statements Is Correct for a Decision