.In attempting to quantify its attitude toward risk, top management of the pharmaceutical company has reported certainty equivalent values for a variety of 50-50 risks. These are summarized in the following table. Outcome of 50-50 Risk Certainty Equivalent $200 and $0 $ 50 $200 and $50 112 $50 and $0 13 $200 and $112 153 $112 and $50 70 $50 and $13 28 $112 and $13 50 For instance, the company's CE for a 50-50 risk between $200 million and $0 is $50 million, and so on. a. Use these responses to determine utility values for each of the monetary valucs in the sccond column. (Hint: Set U($200) = 100 and U($0) = 0. Show that U($50) = 50, U($112) = 75, and so on.) Construct a utility graph by plotting points and drawing a smooth curve. (You may wish to check the utility values in Problem 13 against your curve.) *b. Consider the mathematical utility function U = 7.1Vy, where U is the utility value corresponding to monetary outcome y. Check that this function is an accurate description of the pharmaceutical company's attitude toward risk. Is the company very risk averse?

.In attempting to quantify its attitude toward risk, top management of the pharmaceutical company has reported certainty equivalent values for a variety of 50-50 risks. These are summarized in the following table. Outcome of 50-50 Risk Certainty Equivalent $200 and $0 $ 50 $200 and $50 112 $50 and $0 13 $200 and $112 153 $112 and $50 70 $50 and $13 28 $112 and $13 50 For instance, the company's CE for a 50-50 risk between $200 million and $0 is $50 million, and so on. a. Use these responses to determine utility values for each of the monetary valucs in the sccond column. (Hint: Set U($200) = 100 and U($0) = 0. Show that U($50) = 50, U($112) = 75, and so on.) Construct a utility graph by plotting points and drawing a smooth curve. (You may wish to check the utility values in Problem 13 against your curve.) *b. Consider the mathematical utility function U = 7.1Vy, where U is the utility value corresponding to monetary outcome y. Check that this function is an accurate description of the pharmaceutical company's attitude toward risk. Is the company very risk averse?

Essentials of Economics (MindTap Course List)

8th Edition

ISBN:9781337091992

Author:N. Gregory Mankiw

Publisher:N. Gregory Mankiw

Chapter19: The Basic Tools Of Finance

Section: Chapter Questions

Problem 4CQQ

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5. Investor attitudes toward risk Suppose an investor, Erik, is offered the investment opportunities described in the table below. Each investment costs $1,000 today and provides a payoff, also described below, one year from now. Option Payoff One Year from Now 1 100% chance of receiving $1,100 2 50% chance of receiving $1,000; 50% chance of receiving $1,200 3 50% chance of receiving $200; 50% chance of receiving $2,000 If Erik is risk averse, which investment will he prefer? The investor will choose option 1. The investor will choose option 2. The investor will choose option 3. The investor will be indifferent toward these options. Suppose the market risk premium is currently 6%. If investors were to become more risk-averse, the market risk premium might increase to 8%. What effect would you expect this to have on the prices of most financial assets? Prices would be unaffected. Prices would decrease. Prices would increase.
1. Distinguish between the.'Maximin', 'Maximax·• and the 'Minimax regret' decision strategy. 2.Determining the size or quantum of a possible loss provides a backdrop against which efforts to manage the risk can be measured (Valsamakis et al, 2010:124).Highlight the measures used to enhance the description of possible loss more accurately.
Uncertainty and willingness to pay for insurance. Utility = (Wealth)1/3 Prob(flood) = .04 Prob(no flood) = .96 Total wealth if flood = $100,000. Total Wealth if no flood = $800,000. Find: (i) expected value, (ii) expected utility, (iii) certainty equivalent, and (iv) maximum willingness to pay for a policy that provides 100% flood insurance coverage. Draw the utility function and include all solved values on the diagram. What is the average gross profit per insurance customer, if each customer is charged his own maximum willingness to pay?
D3) What is the misconception of the risk-reward relationship? What is the role and the ultimate goal of the decision maker? Examples, implications.
6 What do the average expected value, standard deviation, and coefficient of variation tell you about loss exposures?
2 Prove rigourously, "Constant relative risk aversion (CRRA) implies decreasing absolute risk aversion (DARA), but the converse is not necessarily true."
Microeconomics Wilfred’s expected utility function is px1^0.5+(1−p)x2^0.5, where p is the probability that he consumes x1 and 1 - p is the probability that he consumes x2. Wilfred is offered a choice between getting a sure payment of $Z or a lottery in which he receives $2500 with probability p = 0.4 and $3700 with probability 1 - p. Wilfred will choose the sure payment if Z > CE and the lottery if Z < CE, where the value of CE is equal to ___ (please round your final answer to two decimal places if necessary)
18.5 Suppose there is a 50–50 chance that an individual with log- arithmic utility from wealth and with a current wealth of $20,000 will suffer a loss of $10,000 from a car accident. Insur- ance is competitively provided at actuarially fair rates. Compute the outcome if the individual buys full insurance. Compute the outcome if the individual buys only partial insurance covering half the loss. Show that the outcome in part (a) is preferred. Now suppose that individuals who buy the partial rather than the full insurance policy take more care when driv- ing, reducing the damage from loss from $10,000 to $7,000. What would be the actuarially fair price of the partial policy? Does the individual now prefer the full or the partial policy?
A9 Describe an example of adverse selection that we may run into in the real world. How does adverse selection impact the policy holders for this specific type of insurance for: High risk participants? Low risk participants? What is one government regulation that has been enacted in the last 20 years that helps either high risk or low risk policy holders in the United States
8 An investor with initial wealth $20000 and utility function U(x) = ln(x) is considering an investment that has a 80% chance of gaining r% and a 20% chance of losing s%. (1) Find in terms of r and s the certainty equivalent of this investment. (2) If s = 10, find the range of values of r for which the investor will avoid this investment.,
470 8 The slope of the utility curves for a strongly risk averse investor, relative to the slope the utility curves for a less risk averse investor will a. be steeper b. be flatter c be vertical d. be horizontal e. be none of above
4 Consider a slip-and-fall case in which a plaintiff is suing a defendant. It is common knowledge that if the case goes to trial the plaintiff will win $30,000 from the defendant with probability 1⁄2 and the plaintiff will win $5,000 from the defendant with probability 1⁄2. a Compute the expected amount of money the plaintiff will win from the defendant if the case goes to trial. b Suppose that the plaintiff has initial wealth of $1,000 and utility function u(c) = c1/2. Let x be the least amount of money that she would be willing to accept from the defendant to settle the case and avoid trial. Carefully set up the equation that defines x by equating her expected utility from settling the case for x dollars and thereby avoiding the uncertainty of the trial with her expected utility from going to trial. Solve the equation for x to the nearest dollar. c Suppose that the defendant has initial wealth of $50,000 and utility function v(c) = log(c). Let y be the most amount of money that…