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Solutions to Problem Set 1

# This has mean 2k and zero variance so the criterion

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Unformatted text preview: you want to maximize the mean ­variance 1 criterion E [ X ] " Var( X ) . 2 c) Would you want to purchase an insurance policy that costs \$2000 and covers all accident costs? Justify. ! Note: The parameter ½ is unrealistic. If you wanted to use the mean variance criterion in practice (which, as we’ll see later in the course, you shouldn’t even though people still do), you would have to pick a much larger parameter. Yes. If you buy insurance, you always pay \$2000. This has mean  2k and zero variance, so the criterion is  2k. If you don’t buy insurance, you save the \$2000 but you pay the damages described in the slides. The damages have mean  860 and variance 5,981,800. The mean variance criterion is then  ­860 ­5,981,800/2 =  ­2,991,760 d) Would you want to purchase an insurance policy that costs \$3000 and covers all accident costs? Justify. The calculatio...
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