solution3

# solution3 - Econ 354K Game Theory Solutions to Problem Set...

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Econ 354K Game Theory Solutions to Problem Set No. 3 1. Draw a decision tree for the executive. 2. Suppose the executive is risk-neutral. Use backwards induction to determine her optimal course of action. Assuming the executive is risk-neutral, then expected utility equals to the expected return. At E2, since 10>-15, choose to exercise 0 options => label E2 with (10) At E3, since 35>10, choose to exercise 1 option => label E3 with (35) At E4, since 0>-25>-50, choose to exercise 2 options=>label E4 with (0) At E5, since 50>25>0, choose to exercise 2 options =>label E5 with (18) At N1, EU=.5*(10)+.5*(35)=22.5 At N2, EU=.5*(0)+.5*(50)=25 At E1, since 25>22.5>20, choose to exercise 0 options today 3. Use information sets to construct a decision tree for the exercise in which Nature moves first. Use backwards induction to determine the executive’s optimal decision in this case. At E1, EU(0|E1)=.5*(0)+.5*(50)=25 (optimum) EU(1|E1)=.5*(10)+.5*(35)=22.5 EU(2|E1)=.5*(20)+.5*(20)=20 E 1 1 today

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## This note was uploaded on 06/09/2011 for the course ECON 354 taught by Professor Econ during the Spring '11 term at University of Texas.

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solution3 - Econ 354K Game Theory Solutions to Problem Set...

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