We showed that the amount an individual is willing to pay to avoid fair gamble (h)is given by...1 answer below »

We showed that the amount an individual is willing to pay to avoid fair gamble (h)is given by ¼0:5Eðh2ÞrðW Þ, where r(W )is the measure of absolute risk aversion at this person’s initial level of wealth. In this problem we look at the size of this payment as function of the size of the risk faced and this person’s level of wealth.

a. Consider fair gamble (v) of winning or losing $1. For this gamble, what is Eðv2Þ?

b. Now consider varying the gamble in part (a) by multiplying each prize by positive constant k.

Let ¼kv. What is the value of Eðh2Þ?

c. Suppose this person has logarithmic utility function (W )ln What is general expression for r(W )?

d. Compute the risk premium (p) for =0.5, 1, and and for =10 and 100. What do you conclude by comparing the six values?

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December 26, 2020answer is...

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