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a) Assume a perfectly competitive insurance market, but where there is a transaction cost of 10% (2 = 0.1). Anest has utility function u(W) =
a) Assume a perfectly competitive insurance market, but where there is a transaction cost of 10% (2 = 0.1). Anest has utility function u(W) = VW and initial wealth of 10,000. She faces a potential loss of 4,000 with probability 1/4. i. What insurance premium will Anest have to pay if she chooses to cover 80% of her potential loss ( = 0.8)? [10%] ii. What is the optimal proportion, , of her loss that Anest should choose to cover? [15%] iii. Calculate Anest's expected utility at her optimal value of , and compare it to her expected utility when = 0 and when = 1. [10%] iv. If Anest's initial wealth had instead been 5,000, what would her optimal have been. Why does it differ in this way? [15%] a) Assume a perfectly competitive insurance market, but where there is a transaction cost of 10% (2 = 0.1). Anest has utility function u(W) = VW and initial wealth of 10,000. She faces a potential loss of 4,000 with probability 1/4. i. What insurance premium will Anest have to pay if she chooses to cover 80% of her potential loss ( = 0.8)? [10%] ii. What is the optimal proportion, , of her loss that Anest should choose to cover? [15%] iii. Calculate Anest's expected utility at her optimal value of , and compare it to her expected utility when = 0 and when = 1. [10%] iv. If Anest's initial wealth had instead been 5,000, what would her optimal have been. Why does it differ in this way? [15%]
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