{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

IFT_Chapt3_sli

# IFT_Chapt3_sli - 3.1 Introduction 3.2 Choosing Among Risky...

This preview shows pages 1–5. Sign up to view the full content.

3.1 Introduction 3.2 Choosing Among Risky Prospects:Preliminaries 3.3 A Prerequisite: Choice Theory Under Certainty 3.4 Choice Theory Under Uncertainty: An Introduction 3.5 Allais Paradox 3.6 Prospect Theory 3.7 Key concepts and ideas Intermediate Financial Theory Chapter III. Making Choice in Risky Situations July 11, 2006 Intermediate Financial Theory

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
3.1 Introduction 3.2 Choosing Among Risky Prospects:Preliminaries 3.3 A Prerequisite: Choice Theory Under Certainty 3.4 Choice Theory Under Uncertainty: An Introduction 3.5 Allais Paradox 3.6 Prospect Theory 3.7 Key concepts and ideas 3.2 Choosing Among Risky Prospects:Preliminaries A future risky cash flow is modelled as a random variable State-by-state dominance =>incomplete ranking « riskier » Table 3.1: Asset Payoffs (\$) Cost at t = 0 Value at t = 1 π 1 = π 2 = 1 / 2 θ = 1 θ = 2 Investment 1 -1,000 1,050 1,200 Investment 2 -1,000 500 1,600 Investment 3 -1,000 1,050 1,600 Intermediate Financial Theory
3.1 Introduction 3.2 Choosing Among Risky Prospects:Preliminaries 3.3 A Prerequisite: Choice Theory Under Certainty 3.4 Choice Theory Under Uncertainty: An Introduction 3.5 Allais Paradox 3.6 Prospect Theory 3.7 Key concepts and ideas Table 3.2: State Contingent ROR ( r ) θ = 1 θ = 2 Investment 1 5% 20% Investment 2 -50% 60% Investment 3 5% 60% Er 1 = 12.5% ; σ 2 1 = 1 2 (5 – 12.5) 2 + 1 2 (20 - 12.5) 2 = (7.5) 2 , or σ 1 = 7.5% Er 2 = 5% ; σ 2 = 55% (similar calculation) Er 3 = 32.5% ; σ 3 = 27.5% Investment 1 mean-variance dominates 2 Investment 3 does not m-v dominate 1! Intermediate Financial Theory

This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document
3.1 Introduction 3.2 Choosing Among Risky Prospects:Preliminaries 3.3 A Prerequisite: Choice Theory Under Certainty 3.4 Choice Theory Under Uncertainty: An Introduction 3.5 Allais Paradox 3.6 Prospect Theory 3.7 Key concepts and ideas Table 3.3: State-Contingent Rates of Return θ = 1 θ = 2 Investment 4 3% 5% Investment 5 2% 8% π 1 = π 2 = 1 / 2 ER 4
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

### What students are saying

• As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

Kiran Temple University Fox School of Business ‘17, Course Hero Intern

• I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

Dana University of Pennsylvania ‘17, Course Hero Intern

• The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

Jill Tulane University ‘16, Course Hero Intern