ps3 - (i) U ( W ) = W , where 0 < <...

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B AYLOR U NIVERSITY H ANKAMER S CHOOL OF B USINESS D EPARTMENT OF F INANCE , I NSURANCE R EAL E STATE Dr. Garven Name ____________________ Problem Set #3 1. A worker whose utility function U ( W ) = W has received a job offer which pays $80,000 with a bonus. The bonus is equally likely to be $0, $10,000, $20,000, $30,000, $40,000, $50,000, or $60,000. Assume that initial wealth is $0. A. What is the expected value of this pay package? B. What is the certainty equivalent of this pay package? C. What is the risk premium? 2. Explain why the utility function U ( W ) = 1.5 2 W is referred to as a constant relative risk aversion utility function. Assuming that < 1, show that this utility function is concave. 3. Consider the following utility functions:
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Unformatted text preview: (i) U ( W ) = W , where 0 &lt; &lt; 1; (ii) U ( W ) = ln W ; (iii) U ( W ) = W e , where &gt; 0; and (iv) U ( W ) = W W 2 , where &gt; 0. A. Which of the above are risk averse utility functions? Be sure to logically justify your answer. B. For each utility function, what is the coefficient of absolute risk aversion? C. For each utility function, what is the coefficient of relative risk aversion? D. Empirical evidence suggests that consumers tend to exhibit decreasing absolute risk aversion and constant relative risk aversion. Which of these utility functions possess both of these two properties?...
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This document was uploaded on 03/08/2010.

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