exo2f - Econ 333 Financial Economics Spring 08 Homework#2...

Info icon This preview shows pages 1–2. Sign up to view the full content.

Econ 333 - Financial Economics Spring 08 Homework #2 Exercise 1: Risk aversion. Consider the following functions (defined over wealth Y): U ( Y ) = Y γ γ U ( Y ) = αY - βY 2 . a - Check that they are well behaved ( U > 0 , U < 0) or state restrictions on the param- eters so that they are. For the second function, take positive α and β , and give the range of wealth over which the utility function is well behaved. b - Compute the absolute and relative risk-aversion coefficients c - What is the effect of parameter γ ? d - Classify the function as increasing/decreasing risk-aversion utility functions (both abso- lute and relative). Exercise 2: Certainty equivalent. Consider the lottery L1 = (50,000; 10,000; 0.50). Determine the lottery L2 = (x;0;1) that makes an agent indifferent with utility function U = ln Y. Exercise 3: An individual (operating in perfect capital markets) with a zero initial wealth, and the utility function U ( Y ) = Y 1 / 2 is confronted with the gamble (16;4;1/2). a - What is the certainty equivalent for this gamble? b - if there is an insurance policy that, together with the original gamble, would guarantee
Image of page 1

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

Image of page 2
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: him the expected payoff of the gamble, what is the maximum premium he would be willing to pay for it? c -What is the minimum required increase (the probability premium) in the probability of the high-payoff state so that he will not be willing to pay any premium for such an insurance policy? (Note that the insurance policy still pays the expected payoff of the unmodified gamble) d -Now assume that he is confronted with the gamble (36;16;1/2). Calculate the certainty equivalent, the insurance premium, and the probability premium for this case as well. Explain what is going on, and why? Exercise 4: Consider two investments with the following characteristics. States State 1 State2 State 3 π 1/3 1/3 1/3 Returns e z 10 10 e y 10 20 a -Is there state-by-state dominance between these two investments? b -Is there FSD between these two investments?...
View Full Document

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern