An expected-utility maximizing DM has current wealth of $90,000. With proba- bility 1/20 she faces a...

 

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An expected-utility maximizing DM has current wealth of $90,000. With proba- bility 1/20 she faces a loss of $50,000. Her utility-of-wealth function is u(w) = √w. (a) What is her certainty equivalent for the "lottery" over wealth she currently faces? (b) Suppose she can purchase insurance of the following form: . She chooses a policy with any amount a 20 • She pays (cx a) for the policy up-front • IF she incurs the loss, the insurance company pays her a dollars. If c = 1/18, what is the optimal amount, a, for her to purchase? (c) Re-answer part (b) for c= .05. Explain anything notable about your answer in words, including how and why it differs from your answer to part (b). An expected-utility maximizing DM has current wealth of $90,000. With proba- bility 1/20 she faces a loss of $50,000. Her utility-of-wealth function is u(w) = √w. (a) What is her certainty equivalent for the "lottery" over wealth she currently faces? (b) Suppose she can purchase insurance of the following form: . She chooses a policy with any amount a 20 • She pays (cx a) for the policy up-front • IF she incurs the loss, the insurance company pays her a dollars. If c = 1/18, what is the optimal amount, a, for her to purchase? (c) Re-answer part (b) for c= .05. Explain anything notable about your answer in words, including how and why it differs from your answer to part (b).

Answer rating: 100% (QA)

a The certainty equivalent for the lottery over wealth she currently faces is 900... View the full answer