3. The day prior to the release of yearly profits, a stock has price equal to 1. An investor is decidingwhether to buy the stock or not. The investor has a wealth equal to 10. Yearly profits can be high withprobability 0.4 or low with probability 0.6. If profits are high, the price will double on the followingday; if profits are low, the price will halve on the following day.If the investor does not buy the stock, her wealth remains unchanged. If the inverstors buys thestock, she will sell the stock on the following day (regardless of whether the profits are high or low)and she will accrue the relative profit or loss. In other words, she cannot hold the stock for more thanone day.The investor does not discount the future and she abides von-Neumann and Morgenstern axioms.Her vNM utility index over money is u (x) = r with 3 E (0,2).• Write down the two possible gambles faced by the investor.• Does the investor buy the stock or not? Explain.• Compute the Arrow-Pratt measure of risk aversion. How does it relate to your previous reply?

Initial Wealth = 10 Price of stock =1 so, investor can buy = 10 stocks U(x) = (x)b

Answered: 3. The day prior to the release of…

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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