(b) You are playing the following game. A coin is tossed. The two possible outcomes are heads and tails. We denote them by 1 and 2 respectively. You can bet on any outcome. The conditions of the bets are as follows. If you bet £1 on outcome 1 and the outcome is 1, then you get back your pound and a reward of £u, where u > 0. But if the outcome is 2 then you lose your pound. If you bet £1 on outcome 2 and the outcome is 2 then you get back £0.5 and a reward of £3u. But if the outcome is 1 then you lose your pound. For what value of u will this game be arbitrage-free? Justify your answer.

(b) You are playing the following game. A coin is tossed. The two possible outcomes are heads and tails. We denote them by 1 and 2 respectively. You can bet on any outcome. The conditions of the bets are as follows. If you bet £1 on outcome 1 and the outcome is 1, then you get back your pound and a reward of £u, where u > 0. But if the outcome is 2 then you lose your pound. If you bet £1 on outcome 2 and the outcome is 2 then you get back £0.5 and a reward of £3u. But if the outcome is 1 then you lose your pound. For what value of u will this game be arbitrage-free? Justify your answer.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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