# InfoPS2a - ECO 7113 Practice Problem Len Cabrera Ralph owns...

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ECO 7113 Practice Problem Len Cabrera Page 1 of 4 Ralph owns a lottery that will pay \$100, \$200, or \$300 with equally likely odds. His utility function is -exp(0.01\$). Determine Ralph's certainty equivalent. Next suppose Ralph sells a stake in this lottery to his cousin. The stake will pay x under 100, y under 200 and z under 300. Determine the optimal x, y, and z assuming cousin's certainty equivalent must be at least zero. Explain the qualitative features of your answer. Oh yes, the cousin's utility function is -exp(-0.02\$ Ralph's Lottery RalphRisk 0.01 Prob. Payoff Utility CousinRisk 0.02 0.33 100 -0.37 =-EXP(-RalphRisk*Payoff1) 0.33 200 -0.14 =-EXP(-RalphRisk*Payoff2) 0.33 300 -0.05 =-EXP(-RalphRisk*Payoff3) E(Utility) -0.18 =SUMPRODUCT(Probabilities,Utilities) CE 169.10 =LN(-RalphExpUtility)/-RalphRisk Selling a Stake Ralph's Tree Prob. Payoff Utility 0.33 (orig pay) (to cousin) (price) 100 - 100 + 126.18 -0.28 0.33 x =-EXP(-RalphRisk*(Payoff1-x+Price)) 200 - 133.33 + 126.18 -0.15 0.33 y =-EXP(-RalphRisk*(Payoff2-y+Price))

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## This note was uploaded on 07/03/2011 for the course ECO 7113 taught by Professor Cpiette during the Spring '10 term at University of Florida.

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InfoPS2a - ECO 7113 Practice Problem Len Cabrera Ralph owns...

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