This preview has intentionally blurred sections. Sign up to view the full version.
View Full DocumentThis preview has intentionally blurred sections. Sign up to view the full version.
View Full DocumentThis preview has intentionally blurred sections. Sign up to view the full version.
View Full Document
Unformatted text preview: Managing Risks: Prelims… • Attitudes towards risk • Risk neutral: indifferent between uncertain outcome and the average outcome • Risk averse: prefers the average outcome to an uncertain outcome • Risk taker: prefers the uncertain outcome (i.e, prefers the gamble) • Note: not the same as different beliefs Risk attitudes: Examples • Suppose individual has $10 • Gamble: bet $x and win $20 or $0 w/ probability (1/2;1/2) • Find the amount $x willing to pay to participate: • If (a) utility U(w)=w (i.e, risk neutral) • If (b) utility U(w)=w 1/2 (i.e., risk averse) • If (c) utility U(w)=w 2 (i.e., risk taker) Risk neutral:… • u 10x 30x 20x 20x U(w)=w 30x 10x Risk neutral: maximum bet If bet $x, the final wealth will be: • For riskneutral, U=w, expected utility is: • Since individual gets utility u=10 if doesn’t not participate, then $x is such that: w x prob x prob = 30 0 5 10 0 5 . . EU x x x [ ] ( . )( ) ( . )( ) =  +  =  05 30 05 10 20 U EU x x ( ) [ ] 10 10 10 20 10 = = ⇒ = ⇒ = Risk neutral: Discussion • The risk neutral investor is indifferent between the expected utility and the utility from consuming the average wealth, $10. • Alternatively, risk neutral individual is not willing to pay a premium to avoid the gamble Risk averse: maximum bet If bet $x, the final wealth will be: • For riskaverse guy, U=w...
View
Full Document
 Spring '08
 KUTSOATI
 Economics, risk averse

Click to edit the document details