Afternoon Exam solutions

False samuelsons result indicates that if you are not

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Unformatted text preview: viduals have concave utility functions; prudent individuals have convex marginal utility functions. Question 4. (5 minutes) People with positively correlated losses do not benefit from pooling risk. False. As long as they are not perfectly positively correlated, they still benefit from pooling risk. Question 5. (5 minutes) Samuelson's result discussed in class shows that anyone who prefers to take a bet once must necessarily like to take the same bet twice. False. Samuelson’s result indicates that if you are not willing to bet once, you must not be willing to bet twice. There is nothing wrong with taking one but not two bets.  ­ 1  ­ Question 6. (5 minutes) In normal mixture models, the distributions of returns are conditional normal distributions. Therefore, these models are unable to generate distributions with fat tails. False. As we saw in class, normal mixture models can generate distributions with fat tails despite the returns being normally distributed conditional on the variance. Question 7. (5 minutes) Suppose gambles A and B have the same mean. If A has a higher variance than B, then B second order stochastically dominates A. False. The fact that A and B have the same mean and that A has a higher variance is not a sufficient condition to claim that A is a mean preserving spread of B. Second order stochastic dominance requires everyone with a concave utility function to prefer one lottery to the other. As we’ve seen in class, some lotteries with the same mean and a higher variance are preferred by some concave utility functions. Therefore, just looking comparing the variances of A and B is not enough to determine whether B se...
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This note was uploaded on 02/03/2014 for the course INSR 205 taught by Professor Kent/smetters/nini during the Spring '09 term at UPenn.

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