Question: Let u = w2 for w 0. (a) Compute the exact risk premium if initial wealth is 4 and if a decision maker faces

Let u = w2 for w ⩾ 0.

(a) Compute the exact risk premium if initial wealth is 4 and if a decision maker faces the lottery (−2, 1 2;+2, 1 2). Explain why the risk premium is negative.

(b) If the utility function becomes v = w4, what happens to the risk pre mium? Show that v is a convex transformation of u.

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