Evening exam solutions

Question 1 5 minutes the value at risk var

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Unformatted text preview: ed to this exam. Signature: Name: Section: Part I: True or False. Justify. (35 minutes) Determine whether each of the following statements is true or false. Answers without justifications will not be graded. Please select either “True” or “False.” Question 1. (5 minutes) The Value at Risk (VaR) is a bad measure of risk because it violates first ­order stochastic dominance. False. VaR violates second order stochastic dominance, not first order stochastic dominance. Question 2. (5 minutes) The Ellsberg paradox shows that people often choose options that are not consistent with subjective expected utility. True. The following two types of justifications are equally good.  You could describe the result in the context the experiment. Subjective expected utility states that people will have a subjective assessment of the probability of black and yellow balls, and choose based on those subjective probabilities. However, no probability is consistent with people choosing options I and IV.  You could alternatively describe our interpretation of the inconsistency between the Ellsberg paradox and subjective expected utility. Most people tend to favor lotteries involving objective probabilities instead of subjective probabilities. Question 3. (5 minutes) Because risk ­averse individuals have concave Bernoulli utility functions while prudent individuals have convex Bernoulli utility functions, it is impossible to be simultaneously risk ­averse and prudent. False. Risk aversion is related to the second derivative of the Bernoulli utility whereas prudence is related to the third derivative. Risk averse individuals have concave utility functions; prudent individuals have convex marginal utility functions. Ques...
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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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