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The term is used in the probability model for economic decisions where the decision-maker can opt for a risk-neutral position. The method Certainty Equivalent (CE) is used in uncertain cash flow situations where the method of probability is used to estimate the occurrence of specific cash flow to get a risk- free rate instead of a risk-adjusted discount. It is one of the types of investment solutions that can get a guaranteed amount of money for eliminating returns on a future date through risk.
For example- if you had like a lottery ticket of $20,000, you will either get the full amount or 0. So you can sell the ticket for $10,000 (the expected monetary value or EMV or the cash money) to get a risk-neutral position, but there are others who may sell it for a lower amount and a decision-maker need to find the certainty equivalent, which can be any amount lower than $10,000. Risk-averse investors try to find a liquidity and cash flow alternative where they may be ready to take less than gambled expected value on investment. The risk premium in such conditions is denoted by RP = EMV- CE. The method is described in the utility theory.
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