This problem is related to the ideas of dominance that we discussed in Chapters 4 and 8.

Question:

This problem is related to the ideas of dominance that we discussed in Chapters 4 and 8. Investment D in the table that follows is said to show "second-order stochastic dominance" over Investment C. In this problem, it is up to you to explain why D dominates C.

You are contemplating two alternative uncertain investments, whose distributions for payoffs are as follows.

a. If your preference function is given by U(x) = 1 − e^{−x /100}, calculate EU for both C and D. Which would you choose?
b. Plot the cumulative distribution functions (CDFs) for C and D on the same graph. How do they compare? Use the graph to explain intuitively why any risk-averse decision maker would prefer D.

Distribution
The word "distribution" has several meanings in the financial world, most of them pertaining to the payment of assets from a fund, account, or individual security to an investor or beneficiary. Retirement account distributions are among the most...