ABSTRACT
In general, it is asserted that to any uncertain future sum of money – to be paid or to be received – there corresponds a guaranteed sum between which and the uncertain sum in question the individual is indifferent. On the more common assumption of risk-aversion for transactions of some
importance, a person is prepared to pay some premium for safety. If, therefore, the expected figure for the sale of his house appears to be $50,000, by accepting a guaranteed price of $45,000 he can be said to be paying a risk premium of $5,000. If, conversely, he is concerned with the problem of buying a particular house in five years’ time, and the most likely price is $80,000, by accepting a guaranteed future price of $86,000, he can be said to be paying a risk premium of $6,000. It goes without saying that the higher the degree of uncertainty about the future price,2 the greater the risk premium a person will be willing to pay.
