Assume the following:

• One period

• Two individuals – Peter and Blair

• Both Peter and Blair own a sailboat valued at 20

• At t = 0 Peter has wealth Y of 70 (including the sailboat) and Blair has wealth Y of 30 (including the sailboat)

• Both Peter and Blair are von Neumann-Morgenstern utility maximizers with the identical utility function U (Y ) = Y^ 0.30

Both Peter and Blair can moor their boat at a public dock or rent a slip at a boating club. If they moor the boat at a public dock there is a 50% probability the boat will be stolen. If the rent a slip at a boating club, the boat will NOT be stolen with certainty. Answer the following:

(a) Derive an expression (function of parameter Y ) for the maximum amount that either Peter or Blair would pay for a slip at a boating club for one year.

(b) Using the expression in part (a), solve for the maximum amount that Peter would pay for a slip at a boating club for one year.

(c) Using the expression in part (a), solve for the maximum amount Blair would pay for a slip at a boating club for one year?

(d) Solve for an expression of the absolute risk aversion RA for U(Y ) = Y ^0.30? Explain your findings in parts (b) and (c) using the concept of absolute risk aversion.

Answer rating: 100% (QA)

6 Yp 40 wealth of Peteo wp 40 Pi 5 Pg5 wp 40 20 50 3D 4y3 We 3020 10 WB 30 3D 3D ... View the full answer