Unformatted text preview: PADP 6950: Founda1ons of Policy Analysis Intertemporal Choice & Uncertainty PRACTICE Angela Fer1g, PhD Point of these exercises Try out a calcula1on on your own Make sure you understand some concepts Demonstrate that people have different discount rates and different degrees of risk aversion 1 How surveys try to es1mate your discount rate Imagine you are 65 years old, and you are receiving $1,000 per month in Social Security benefits. Suppose you had a choice: either you could keep that $1,000 monthly benefit for life, or you could exchange it for a monthly benefit half that size, $500 per month for life, plus you'd get a one1me, lump sum payment. What is the smallest lumpsum that you would be willing to accept in exchange for reducing your life1me benefit by $500 per month? ENTER 0 if would not take at any price. [HRS] What is your discount rate "rank" in the class? 2 How surveys try to es1mate your level of risk aversion Suppose that you are the only income earner in the family. Your doctor recommends that you move because of allergies, and you have to choose between two possible jobs. The first would guarantee your current total family income for life. The second is possibly be^er paying, but the income is also less certain. There is a 5050 chance the second job would double your total life1me income and a 5050 chance that it would cut it by a third. Which job would you take  the first job or the second job?" If chose second job: Suppose the chances were 5050 that the second job would double your life1me income, and 5050 that it would cut it in half. Would you take the first job or the second job? 3 If chose second job again: Suppose the chances were 5050 that the second job would double your life1me income and 5050 that it would cut it by seventyfive percent. Would you take the first job or the second job? If you chose the first job: Suppose the chances were 5050 that the second job would double your life1me income and 5050 that it would cut it by twenty percent. Would you take the first job or the second job? 4 If you chose the first job again: Suppose the chances were 5050 that the second job would double your life1me income and 5050 that it would cut it by 10 percent. Would you take the first job or the second job? Figure out your score Job1 (certain over 50% chance of 33% cut) (50% chance of 33% cut over certain) Job 2 (certain over 50% chance of 20% cut) Job 1 (50% chance of 20% cut over certain) Job 2 (certain over 50% chance of 50% cut) Job 1 (50% chance of 50% cut over certain) Job 2 (certain over 50% chance of 10% cut) Job 1 (50% chance of 10% cut over certain) Job 2 4 3 (certain over 50% chance of 75% cut) Job 1 (50% chance of 75% cut over certain) Job 2 6 5 2 1 5 Let's keep track of your risk aversion "rank" in the class How many had a score of 6? 5? 4? 3? 2? 1? Deal or No Deal? One volunteer to play online game to get us all familiar with the game Everyone else use record sheet to keep track of what you would have done if you were the player How Game Works Choose 1 of 26 sealed briefcases that have secret values ranging from 1 cent to $1 million player doesn't know its value and keeps it un1l it is unsealed at the end of the game A "banker" will offer you cash with certainty in exchange for your briefcase which has an uncertain value; you choose whether to accept the bankers offer (deal) or keep your briefcase (no deal) The expected value of the briefcase changes as more informa1on about the other 25 briefcases are revealed through a process where the player picks n briefcases to unveil; aker each unveiling of the n briefcases, the banker makes a new offer 6 Let's play h^p://www.nbc.com/Deal_or_No_Deal/game/flash.shtml Play all the way through even if player chooses deal. Calculate your risk premium Work in groups The concept of risk premium in this context: Risk premium = EV of my briefcase offer with risk no risk Calculate an actual dollar risk premium given your choice of when to take the deal. If you didn't ever take the banker's offer, you will calculate an upper bound instead. Help everyone in the group, regardless of choice, figure out their risk premium. 7 Let's look at our data If took 1st offer, what is your risk premium? How many people took 1st offer? If took 2nd offer, what is your risk premium? How many people took 2nd offer? Etc. Let's play again with more info Choose another player New record sheets Take more 1me between rounds to calculate some info: Percent chance of winning $1 million Expected value Then make choices about banker's deal Let's see if our distribu1on of risk premiums change with be^er informa1on 8 ...
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 Spring '11
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