Chapter 17 - Uncertainty

Question 1

Someone who is risk neutral has a …

Answer 1

constant marginal utility of wealth: Each extra dollar of wealth raises utility by the same amount as the previous dollar.

Question 2

In general, a risk neutral person chooses the option with the…

Answer 2

highest expected value, because maximizing expected value maximizes utility.

Question 3

An individual with an increasing marginal utility of wealth is …

Answer 3

risk preferring: willing to take a fair bet

Question 4

Fair Bet

Answer 4

A wager with an expected value of zero

Question 5

Risk Averse

Answer 5

unwilling to make a fair bet

Question 6

Risk Neutral

Answer 6

Indifferent about making a fair bet

Question 7

Risk Preferring

Answer 7

Willing to make a fair bet

Question 8

Risk Premium

Answer 8

The amount that a risk averse person would pay to avoid taking a risk

Question 9

A person whose utility function is concave picks…

Answer 9

the less risky choice if both choices have the same expected value

Question 10

How can we classify people’s risk preference?

Answer 10

Their willingness to make a fair bet

Question 11

Holding the expected value constant, the smaller the standard (or variance)

Answer 11

the smaller the risk

Question 12

Instead of describing risk using variance…

Answer 12

they report it based on standard deviation which is the square root of the variance

Question 13

A probability is

Answer 13

a number between 0 and 1 that indicates the likelihood that a particular outcome will occur

Question 14

Investing Under Uncertainty

Answer 14

Whether people make an investment depends on the riskiness of the payoff, the expected return, attitudes toward risk, the interest rate, and whether it is profitable to alter the likelihood of a good outcome

Question 15

Behavior Economics of Risk

Answer 15

Because some people do not choose among risky options the way that traditional economic theory predicts, some researchers have switched to new models that incorporate psychological factors

Question 16

Avoiding Risk

Answer 16

People try to reduce their overall risk by not making risky choice, taking actions to lower the likelihood of a disaster, combining offsetting risks, insuring, and in other ways.

Question 17

Degree of Risk

Answer 17

Probabilities are used to measure the degree of risk and the likely profit from a risky undertaking

Question 18

Decision Making Under Uncertainty

Answer 18

Whether people choose a risky option over a non-risky one depends on their attitudes toward risk and on the expected payoffs of each option

Question 19

Risk

Answer 19

Situation in which the likelihood of each possible outcome is known or can be estimated and no single possible outcome is certain to occur

Question 20

The simplest way to avoid risk is to …

Answer 20

abstain from optional risky activities

Question 21

Diversification can eliminate risk if…

Answer 21

two events are perfectly correlated

Question 22

The extent to which diversification reduces risk depends on…

Answer 22

the degree to which various events are correlated over states of nature

Question 23

The degree of correlation ranges from …

Answer 23

negatively correlated to uncorrelated to positively correlated

Question 24

If you know that the first event occurs,

Answer 24

you know that the probability that the second event occurs is lower if the events are negatively correlated and higher if the events are positively correlated

Question 25

The outcomes are independent or uncorrelated if…

Answer 25

knowing whether the first event occurs tells you nothing about the probability of the second event occurring

Question 26

Diversification reduces risk even if the two events are …

Answer 26

imperfectly negatively correlated, uncorrelated, or imperfectly positively correlated.

Question 27

The more negatively correlated two events are..

Answer 27

the more diversification reduces risk