Bea is an expected utility maximizer with von Neumann-Morgenstern utility u(x) = x². She has an initial wealth of w≥ 3. A colleague offers her a bet that has a 50-50 chance of winning 2 or losing 3 (giving final wealth of w+2 and w-3, respectively). (a) For each w, find the risk premium associated with taking the bet. (b) For what values of w (if any) is Bea willing to accept the bet? Is she more inclined to accept when her wealth is lower or when it is higher? (c) Calculate the Arrow-Pratt measure of absolute risk aversion as a function of w.

Bea is an expected utility maximizer with von Neumann-Morgenstern utility u(x) = x². She has an initial wealth of w≥ 3. A colleague offers her a bet that has a 50-50 chance of winning 2 or losing 3 (giving final wealth of w+2 and w-3, respectively). (a) For each w, find the risk premium associated with taking the bet. (b) For what values of w (if any) is Bea willing to accept the bet? Is she more inclined to accept when her wealth is lower or when it is higher? (c) Calculate the Arrow-Pratt measure of absolute risk aversion as a function of w.

Microeconomic Theory

12th Edition

ISBN:9781337517942

Author:NICHOLSON

Publisher:NICHOLSON

Chapter7: Uncertainty

Section: Chapter Questions

Problem 7.10P

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