Angner\'s book: Exercise 3.20, 3.21, 3.22, 3.25, 7.7 Normally, Bob is unwilling
ID: 1192900 • Letter: A
Question
Angner's book: Exercise 3.20, 3.21, 3.22, 3.25, 7.7 Normally, Bob is unwilling to accept a lottery' that pays him $1000 and -$1100 with equal probabilities 0.5. Yet after he loses $1000 in a stock market, he agrees to this lottery. Explain Bob's behavior. Suppose that v(x) = x and v(-x) = -2x for positive x > 0. Let pi (0.001) = 0.005 and pi(0.999) = 0.995. According to the prospect theory, what is the maximal price that this person is willing to pay to insure a $2000 TV set that breaks down with probability 0.001? (Assume that TV needs to be replaced in this case.) The value function v in the prospect theory is linear; is concave; has a kink at the reference point; none of the above. The weighting function pi(p) in the prospect theory accommodates buying lottery tickets and Allais Paradox; loss aversion ; risk aversion for gains and risk loving for losses; all of the above. Suppose that v(x) = square root x and v(-x) = -2square root x for positive x > 0. Let pi (p) = p for all 0Explanation / Answer
1) Kindly post the question in qa to get the answer.
2) Expected value of the lottery EV = 1000*0.5 - 1100*0.5 = - 50 $
Variance of the outcome of the lottery:-
(Variance) = 0.5 * (1000- (-50))^2 + 0.5* (-1100-(-50))^2 = $1102500
=> Standard Deviation = sqrt(1102500) = 1050 $
Since, he lost 1000$ in a lottery he still invests in lottery as a risk loving person beacuse in the new lottery also the expected value of lottery is very low or is negative.
4) c) has a kink at the reference point ---- below reference covers loses and above reference is for gains.
5) c) risk aversion for gains and risk loving for loses --- because it is a function of probabilty of gain or loss.
6) D) all the above