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?
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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?
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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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This note was uploaded on 05/07/2009 for the course PAM 4230 taught by Professor Tennyson during the Spring '07 term at Cornell University (Engineering School).

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

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