Lotteries A and B have the same expected value, but B has larger variance. Which of the following statements is true, all else equal?
A)If the decision maker is risk averse, lottery A will have the larger risk premium.
B)If the decision maker is risk neutral, lottery B will have the larger risk premium.
C)If the decision maker is risk loving, both lotteries will have a positive risk premium.
D)If the decision maker is risk averse, lottery B will have the larger risk premium.

Question

Quizplus · Accepted Answer

If the decision maker is risk averse, they will require a higher risk premium for taking on the larger variance associated with lottery B. Therefore, option D is the correct answer. Option A is incorrect because if the decision maker is risk averse, they would prefer the lottery with a smaller variance (lottery A) regardless of the risk premium. Option B is incorrect because the risk premium is not determined by the decision maker's risk neutrality. Option C is also incorrect because risk-loving decision makers do not necessarily require a positive risk premium for both lotteries.

Lotteries a and B Have the Same Expected Value, but B