ECON 230D1 Lecture Notes - Lecture 17: Risk Neutral
25 Dec 2016
School
Department
Course
Professor
Document Summary
The build intuition, consider a game of heads and tails for money: heads, the player has to pay y$, tails, she has to pay x$ The basic model assumes that individuals maximize expected utility . The structure of the gamble: calculate expected value, 1. Heads or tails could come up: 2. Associated with the state of the world. Expected value: consider the average over the pay offs using the probabilities of the outcomes as weights. If y=0 and x=1, then: (cid:2869)(cid:2870)+(cid:2869)(cid:2870)=(cid:882). (cid:887: this is called an expected value, = avg. pay off from playing the game. If you play this game often enough, the avg pay off will approach the expected value. A risk neutral gambler: someone is risk neutral if they do not display a preference for or against risk. Accepts only based off of avg. of that gamble, paying no heed to riskiness inherent in the gamble: example:
