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Lecture

12_Outline_Choices+Involving+Risk.pdf

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Department
Economics
Course
ECON 3P21
Professor
All Professors
Semester
Fall

Description
11-2   11-4            o nature  iven of  hose  dd appen risk   percentage   f     is isertain  ill  hat  r      tates  lways  , a at ta wo hat states  opics  anaging  nd     f    omething of    ll    ikelihoodmeanmeans   t at Main Probabthety   1   probability  isk?    f o    will    f occuretween probabilities ertain  s  ethods      reference will  he  tat robabilities    umber  btain What Insu Orthncer  easureA ProbProAddtotwo since • • • • A state – – – – LO 1 •         11-3   each      thers  f  hiunfold  n   describing because  an    xperienc ut  isk  ay  y  e state    ules  egin  ne  isk onsequpossibleion  hoice,  hat  s      haway Involving  he  ne isky     is    ecision,  at reen What  o naturek f  ncertain  isky  heneve ature    f state Choices  re  f relevant    xp sienceed exists    tat om nee   state  nalyze Canstate Risdecisionentso everOncey – • • • • LO 1     11-6 11-8  ts  rom   as  ayoff    oss  hoice 500,000 500,000  r  ossible ayoff  ain xpected  xample)  he each its (an  inancial          ll  f  f  f average Value     the calculate      ayof verage 8,5000,000 4,50 20%,0000 1200%00,000000 900,000000  robability  xpected  hoice  he 11.1:  etermine   ExpecWeigpayU ofsssiT ghtaisky • • • TabLarge FactErxSctdlpayoffE)xpecPoyoafflfi$PPoobailiix Pa LO 1 LO 1     11-5 11-7   of   Small    ayoffsfactory  egative et and or    ach     of Lafactory  onsequences,  hat Payoff (NPV, $ million)  gains)  robabilities, 20-1.530-1.52-0.-1.5-058.5-0.5 +4.5  ayofinancial  ccur Probability   likelihood  istrib illn Nature,  ave  ositive the    e    f Uncertain  an  ivesayoff  tates choices    robability  1.1: RispayP oafysoffsees)yoffssible • • • LO 1 Table StatePatentPaperotepdootned,eptLO 1ed,roved,       11-10         11-12    f a    f the    ess  ff  he squared of its bundle     oot        ayoof Risk  hi h,e always  etter  eviation     aisky  er sinty onsumption  etween square andof   the  nd  alue    arcal ulatingn    ouoff   expected  he     bundle  ndividual    s  he y     t eted  he  onsumptio erson,  iffere xpected  tandard Equivaequ va entainty,  c ns ameion  ariabil nd  ayits        akes  f ise  he  easur   withqua‐verse  herisk   is  eviation  r      ayoff  mount  isk  xpected  arianceinancial Certai tytainty   Measures TheiseproconsForeqeurivalenthng Deavcittiolnnceaathenardnomistsance • • • • • • LO 1 LO 2       11-9       11-11  f    s  f      f  ange  ayoff  isk  he a  klevel    anwhen  ayoff    isk voirisk   same he    ndication whenigh  xpected    omconsumption      ctual  he   wa ome   isd  easur ow nd  he  omparin refnot    y  s  he o  n  ith e    nd  ide  version,  o a cep de xpected payoff  isk  ar ow Varia ility   gains  s  lose Risk aversendle of  f  ariabilitvariability,    ec igher    ayoffs  isk isky  ndi ndivid als  inancial ayoffs  lways  s    onsumption, hey  ikelyttle  o  orm Genlikofy,  ver verse Variabilityariability Withlmost A bune dlpRiskRiskproinded • • • LO 1 • • • LO 2     11-14     11-16  isk  he W(F)  isk    eutthe   toward Fncreases),     ncreases),  isk 11.6) Aversionfunction,  s  s        s  reater Risk  ttitude  he (Figure    teeper    nd  enefit  ovi onsumer  he  fl ver eeriskthe  f  s   Aversion  tili ynsumer’s isk  oncavity,   the  oncave onvex  ine r, Risk   shap r  s  s   Expected he W(F) W(F)onsW(F)greater If consumerhe If   Determine – – Theaversion LO 2 • • LO 2     11-13  f     11-15    ts  he state  enefits s  s    enefit    ertainty  evel FH  hose W bundle  ossconsumedposs ble     s    f  Func ions  aluell 1  isk xpe onsumer’s    o  f  uncton:    ts  hat S  remiof  he  tilleveln  tility    xpe ted gebability W Risk  nd  nly  between  he  he  premium Expe tedfit  xpectHd    ase ake eig tedg , risk   Fs   AssinatuThen levelsweiS ghmt ple   The differenceptionent • • • • LO 2 LO 2          f   11-18   11-20  y      he    ut  s  ain       reducesy is   l sses  heir  o  isks      older  ecause cancels  f  ha ome  or it  olicy olicy  ai over actuariallyilling range  ith theccurs,umer    urchaser’s        he  n  re  nsurance aontract  oss Policiesust  he because  f aid olisies    
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