2 Consider the two investments listed below with possible outcomes and probabilities: INVESTMENT (in $1000) SAFE RISKY INVESTMENT+ AMOUNT 40€ 40€ GOOD SCENARIO OUTCOME 45 80+ AVERAGE SCENARIO PROB OUTCOME 0.40 0.40€ 42° 45° BAD+ SCENARIO PROB OUTCOME 0.20€ 0.20 35€ 10€ PROB 0.40€ 0.40€ a) Suppose I have utility function U(*) = (x)². What is the expected utility from each investment? b) Which investment will I choose, if any? Show and explain your work and provide the intuition. c) What is the value of the risk premium for the SAFE investment? Show and explain your work and provide the intuition. d) What is the value of the risk premium for the RISKY investment? Show and explain your work and provide the intuition. P 13 P

2 Consider the two investments listed below with possible outcomes and probabilities: INVESTMENT (in $1000) SAFE RISKY INVESTMENT+ AMOUNT 40€ 40€ GOOD SCENARIO OUTCOME 45 80+ AVERAGE SCENARIO PROB OUTCOME 0.40 0.40€ 42° 45° BAD+ SCENARIO PROB OUTCOME 0.20€ 0.20 35€ 10€ PROB 0.40€ 0.40€ a) Suppose I have utility function U(*) = (x)². What is the expected utility from each investment? b) Which investment will I choose, if any? Show and explain your work and provide the intuition. c) What is the value of the risk premium for the SAFE investment? Show and explain your work and provide the intuition. d) What is the value of the risk premium for the RISKY investment? Show and explain your work and provide the intuition. P 13 P

Microeconomic Theory

12th Edition

ISBN:9781337517942

Author:NICHOLSON

Publisher:NICHOLSON

Chapter7: Uncertainty

Section: Chapter Questions

Problem 7.8P

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