Question 2: [13 marks total] Ann has a 20 million dollar house. Suppose there is a...

 

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Question 2: [13 marks total] Ann has a 20 million dollar house. Suppose there is a p chance that house is safe from fire, and a 1 – p chance of a fire, in which case the house is completely destroyed and Ann retains the value of the land, 5 million dollars. Assume Ann has utility of money given by u(m) = In m, and that her preferences can be characterized by the expected value of her utility of money. A risk neutral investment company is considering offering Ann a contract. After the contract Ann's final wealth will be S in the "safe state of the world" and F in the "fire state of the world." Without a contract Ann's final wealth will be So respectively, this is the "lottery" Ann is endowed with. 20 and Fo = 5 %3D (a) [4 marks] Plot the "lottery" that Ann is endowed with on a graph, labeling it H. Assume the safe state of the world is on the horizontal axis and the fire state of the world is on the vertical axis. Suppose the investment company is willing to offer any actuarially fair contract to Ann. Suppose p available to Ann after contracting with this company. Plot Ann's indifference curve that passes through the lottery that she is endowed with. Plot the highest indifference curve Ann can reach by obtaining a contract with the insurance company. What will Ann's final wealth be in each state of the world with this optimal contract? Show your work. .9. Plot all the final wealth (S, F) combinations (b) [3 marks] An a new graph again plot the "lottery" that Ann is endowed with on a graph, labeling it H. Again have the safe state of the world on the horizontal axis and Question 2: [13 marks total] Ann has a 20 million dollar house. Suppose there is a p chance that house is safe from fire, and a 1 – p chance of a fire, in which case the house is completely destroyed and Ann retains the value of the land, 5 million dollars. Assume Ann has utility of money given by u(m) = In m, and that her preferences can be characterized by the expected value of her utility of money. A risk neutral investment company is considering offering Ann a contract. After the contract Ann's final wealth will be S in the "safe state of the world" and F in the "fire state of the world." Without a contract Ann's final wealth will be So respectively, this is the "lottery" Ann is endowed with. 20 and Fo = 5 %3D (a) [4 marks] Plot the "lottery" that Ann is endowed with on a graph, labeling it H. Assume the safe state of the world is on the horizontal axis and the fire state of the world is on the vertical axis. Suppose the investment company is willing to offer any actuarially fair contract to Ann. Suppose p available to Ann after contracting with this company. Plot Ann's indifference curve that passes through the lottery that she is endowed with. Plot the highest indifference curve Ann can reach by obtaining a contract with the insurance company. What will Ann's final wealth be in each state of the world with this optimal contract? Show your work. .9. Plot all the final wealth (S, F) combinations (b) [3 marks] An a new graph again plot the "lottery" that Ann is endowed with on a graph, labeling it H. Again have the safe state of the world on the horizontal axis and

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185 O The endowment is Fair 18 So 20 Fo 25 premium Expected value compensations p... View the full answer