What is a certainty equivalent?

A certainty equivalent refers to the guaranteed amount of money that an individual would consider to be equally as desirable as a risky investment or uncertain payoff. This concept is often used in the context of decision-making under risk and reflects the individual's risk tolerance.

When someone has the option to take a gamble with a certain expected monetary value, they might prefer to take a smaller, guaranteed amount instead of risking it for a potentially higher but uncertain return. The maximum sum of money a person would pay to participate in an opportunity is indeed aligned with this concept, as it indicates the value they ascribe to that uncertain opportunity compared to a guaranteed outcome.

In contrast, the other options do not capture the essence of certainty equivalent as accurately. The minimum expected payout from a risky investment could refer to various scenarios without addressing the guaranteed aspect that certainty equivalent embodies. A guaranteed return on investment pertains specifically to investments with no risk, while the exact amount equivalent to a sure bet does not accurately convey the subjective nature of how individuals perceive and evaluate risk and certainty.