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 had the expected payoff of the lottery are equal?
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 will require a positive risk premium to bear risk. This is because a risk-averse decision maker prefers the sure thing over a gamble with the same expected payoff due to their diminishing marginal utility of wealth. The risk premium is the amount of additional expected value that a decision maker requires to choose the gamble over the sure thing. Since the expected payoffs are equal, the risk-averse decision maker will require a positive risk premium to compensate for the uncertainty associated with the lottery. Risk-loving decision makers would choose the lottery, while risk-neutral decision makers would be indifferent between the sure thing and the lottery.

Which of the Following Statements Is Correct for a Decision