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Investment Option VAO CCO MAO Strong Growth Economy $ 35 million $ 45 million $ 10 million Improving Economy $ 30 million $ 40
Investment Option VAO CCO MAO Strong Growth Economy $ 35 million $ 45 million $ 10 million Improving Economy $ 30 million $ 40 million $ -10 million Stable Economy $ 10 million $5 million $ -10 million Worsening Economy $ -10 million $ -20 million $25 million a. Draw and label the decision tree that describes the decision facing Mark Smith. Be sure to include the do-nothing-alternative as an option. (10) b. Suppose that Smith is an EMV decision maker. Suppose he has estimated the probabilities of the potential outcomes as so: P(Strong Economy)=.2, P(Improving Economy)=.2, P(Stable Economy)= .4, P(Worsening Economy)=.2. Determine the optimal alternative. (20) c. Develop a reasonable (non-pathological) risk averse preference curve for monetary amounts between - $ 20 million and $ 45 million. Determine the preferred strategy for the decision maker that you've modeled with your curve, assuming the probabilities cited in part (b). (15) d. For the EMV decision maker modeled in part b, determine what perfect information would be worth. (15) e. Suppose one of Smith's colleagues has convinced Mark that a "worsening economy" will not occur. If that colleague were completely reliable, when would it be appropriate for Smith to choose the countercyclic investment strategy? (10) [try not to read too deeply into this question; no additional assumptions should be required]
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