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Lecture 17 - Insurance Problems

# Lecture 17 - Insurance Problems - Risk Aversion and...

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Risk Aversion and Insurance Purchase A small business owner has initial wealth of \$20,000 faces the following probability distribution of losses to his wealth: Loss Probability \$0 0.8 \$5,000 0.1 \$20,000 0.1 The business owner makes decisions that maximize his expected utility of wealth: U(W) = W 1/2 . Will the business owner want to purchase insurance for these losses?

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Risk Aversion and Insurance Purchase 1.What is the business owner’s probability distribution of wealth? 2.What is the business owner’s expected utility without insurance?
Risk Aversion and Insurance Purchase 3.What is the minimum amount that we should expect insurance to cost? 4. What is the business owner’s expected utility if insurance costs this amount?

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Risk Aversion and Insurance Purchase 5.What is the maximum amount that the business owner will pay for insurance?
Suppose instead that the business owner is risk- neutral and makes decisions to maximize his expected wealth. What is the most that he will pay for insurance if

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Lecture 17 - Insurance Problems - Risk Aversion and...

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