An individual has two assets: $13 in the bank and her house. The house is worth $12 when there is no fire (with probability ¼), and $3 when there is fire (with probability ¾). She is an expected utility maximizer and her Bernoulli utility function on wealth is u(w) = w1/2 Calculate the expected value of her house, the CE of her house, and the risk premium for her house. She is thinking of buying half fire insurance, that is she will pay a premium P, and the insurance company will pay half of the damage in case of fire. The insurance company she deals with wants the insurance Premium, P, to be paid upfront whether there is a fire or not (thus, but she must pay the Premium P even when her house catches fire). Calculate the highest premium P she would pay. Now, calculate the highest premium she would pay for full insurance. Is the premium you found is twice of the premium in part (b). Can you explain why (or, why not)?

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expected value of her house 1412 343 75 CE of her house u75 7512 27 risk premium ... View the full answer