Abstract
This article studies an agent's valuation of the right to trade in a complete contingent claims market. The proposed measure generalizes the Pratt (1964) risk premium, which captures the willingness to pay to replace a given risky wealth prospect with an actuarially equivalent, nonrisky wealth. Specifically, we define ageneralized risk premium to be the willingness to pay to trade at going market prices. If state prices are actuarially fair, the Pratt premium is obtained as a special case. We derive several properties of this generalized premium and note its relationship to the option price of a public project under uncertainty.
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The authors are indebted to an anonymous referee of this journal for helpful comments. We would also like to thank Robert Brooks, Guenter Franke, John Hey, David Mandy, V. Kerry Smith, Paul Thistle, and participants in the Finance Workshop at Tel-Aviv University for their comments on earlier drafts of this article.
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Schlee, E.E., Schlesinger, H. The valuation of contingent claims markets. J Risk Uncertainty 6, 19–31 (1993). https://doi.org/10.1007/BF01065348
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DOI: https://doi.org/10.1007/BF01065348