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What is the certainty equivalent of a gamble?

  • A.The expected monetary value of the gamble computed in the usual way
  • B.The amount an agent would pay to avoid facing the gamble at all
  • C.The utility of the gamble expressed in monetary units of measure
  • D.The sure amount an agent would accept instead

Answer: D

The certainty equivalent is the sure sum whose utility equals the gamble's expected utility, and it falls below the expected value for a risk-averse agent. The gap is the insurance premium. Expected value, avoidance payment and utility rescaling are related but distinct. Computing it once for a concave curve makes the whole vocabulary of risk premiums fall into place.

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