Certainty Equivalent
Categories: Metrics, Accounting
That calm, assured feeling politicians must get when they start talking about things like science or the economy.
Actually, a certainty equivalent represents a classic game show situation. You've won $5,000. You're dressed up like a pirate for some reason. The game show host says you can keep the $5,000 or go for the prize in the super-secret mystery box. The mystery prize could be a million dollar check. It could be a worthless gag gift. Do you take the guaranteed $5,000 or take the risk and go for what's in the box?
The certainty equivalent represents the amount you'd have to be guaranteed to give up the chance at the bigger prize. If the $5,000 is at or above the certainty equivalent, you should stick with that and pass on the box.
The certainty equivalent can be figured out with mathematical equations, assuming you know enough about the parameters. The amount you could win, the chances of the various outcomes, etc. Put those into the equation and you get the proper certainty equivalent.
