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Unformatted text preview: Von Neumann-Morgenstern: Lecture XI Charles B. Moss September 14, 2010 I. Numerical Stuff A. In the preceding lecture, we found the expected utility of a gam- ble that paid $150,000 with probability of 0.6 and $50,000 with probability 0.4. Assuming a r = 0 . 5, the power utility function yields a certainty equivalent of $103,569. B. Lets work on a slightly different problem, again assume that we have a risky gamble that pays $150,000 with some probability p and $50,000 with probability (1 − p ). 1. I assert that we can find a p that makes the decision maker indifferent between the risky gamble and a certain payoff of $108,000. Naturally, we assume that p is higher than 0.6 (why?). 2. Using our power utility function, we know that U (108 , 000) = 108 , 000 . 5 . 5 = 657 . 27 (1) C. Changing the problem slightly, assume that the payoffs are $150,000 with probability 0.6 and $50,000 with probability 0.4. What is the r required to make the certainty equivalent $108,000?...
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This note was uploaded on 07/15/2011 for the course AEB 6182 taught by Professor Weldon during the Fall '08 term at University of Florida.
- Fall '08