Chapter 14

Question 1

expected value

Answer 1

the probability - weighted average payout
formula : E[V] = (p1 x M1) + (p2 x M2) +… where p = probability value and M = payout value

Question 2

Risk averse

Answer 2

utility of the lottery is less than the utility of the expected value of the lottery (E[U] < U(E[V]); means that you accept an E[V] loss from uncertainty, or are willing to pay to have that risk reduced

Question 3

expected utility

Answer 3

probability - weighted average utility
formula: E[U] = p1 x U(M1) + p2 x U(M2)… where p = probability, U = agent’s utility fxn, and U(Mn) is just U with payout value plugged in02

Question 4

Risk Neutral

Answer 4

E[U] = U(E[V]), indifferent about uncertainty

Question 5

risk loving

Answer 5

E[U] > U(E[V]); uncertainty is good

Question 6

Certainty equivalent

Answer 6

guaranteed income level in which someone would receive the same E[U] regardless if income was certain or uncertain (represented by the original utility curve)

Question 7

Risk premium

Answer 7

compensation an individual would need to take on risk w/o suffering a loss in E[U]

Question 8

complete / full insurance

Answer 8

an insurance policy that leaves the uninsured equally well off regardless of outcome

Question 9

actuarially fair insurance

Answer 9

insurance policy with expected net payments = 0 ; the payout amount x probability of adverse event occurring