Consider Richard has the following value function under prospect theory: v(w) w when w>0 =-2(-w) when...

  

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Consider Richard has the following value function under prospect theory: v(w) w when w>0 =-2(-w) when w<0 Richard is deciding whether to buy a state lottery ticket. Each ticket costs $1, and the probability of the following winning payoffs is given as follows: Probability 0.50 0.25 0.20 0.05 Return $0.00 $1.00 $2.00 $7.50 7.1 Is this individual loss-averse? Explain. What is the difference between loss aversion and risk aversion? (4 points) 7.2 Would Richard buy the ticket? (6 points) 8 Question worth 10 points An investor is confronted with the following investment possibilities: today 1 year 2 years Bond: rises 1.04 1.02 rises falls rises falls 0.98 Bond: rises 1.04 1.02 rises falls rises falls 0.98 falls 0.96 rises 1.21 1.1 rises Shares: falls rises 1.03 falls 0.94 falls 0.88 the probabilities for "rises" and "falls" are identical (= 0.5). Mike is a "Prospect Theory"-investor with a value function as proposed by Kahneman and Tversky and his reference point is his initial wealth (The interest rate factor is assumed to be 1+1=1). His utility function is: |u(x)= {-A- \-B(-x) if x≥0 if x<0 where α=0.88 . Please use the interest rate factors provided above for the calculation of the x (e.g. 1; 1.02; 1.04) Which investment (bonds or shares) would Mike prefer if he had a one year investment horizon? Which investment would he prefer if he had a two year horizon? Assume ẞ-2. Explain the results. (10 points) Consider Richard has the following value function under prospect theory: v(w) w when w>0 =-2(-w) when w<0 Richard is deciding whether to buy a state lottery ticket. Each ticket costs $1, and the probability of the following winning payoffs is given as follows: Probability 0.50 0.25 0.20 0.05 Return $0.00 $1.00 $2.00 $7.50 7.1 Is this individual loss-averse? Explain. What is the difference between loss aversion and risk aversion? (4 points) 7.2 Would Richard buy the ticket? (6 points) 8 Question worth 10 points An investor is confronted with the following investment possibilities: today 1 year 2 years Bond: rises 1.04 1.02 rises falls rises falls 0.98 Bond: rises 1.04 1.02 rises falls rises falls 0.98 falls 0.96 rises 1.21 1.1 rises Shares: falls rises 1.03 falls 0.94 falls 0.88 the probabilities for "rises" and "falls" are identical (= 0.5). Mike is a "Prospect Theory"-investor with a value function as proposed by Kahneman and Tversky and his reference point is his initial wealth (The interest rate factor is assumed to be 1+1=1). His utility function is: |u(x)= {-A- \-B(-x) if x≥0 if x<0 where α=0.88 . Please use the interest rate factors provided above for the calculation of the x (e.g. 1; 1.02; 1.04) Which investment (bonds or shares) would Mike prefer if he had a one year investment horizon? Which investment would he prefer if he had a two year horizon? Assume ẞ-2. Explain the results. (10 points)

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71 Loss aversion refers to the tendency for individuals to experience losses more intensely than the... View the full answer