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Q2. (4x3 - 12) Suppose an investors utility function is given by 1. Consider an investor with initial wealth W-1000, taking on a bet which
Q2. (4x3 - 12) Suppose an investors utility function is given by 1. Consider an investor with initial wealth W-1000, taking on a bet which is equally likely to yield 10 or -10. Calculate his Arrow Pratt local risk aversion. 2. Suppose you are exposed to a situation where you have a 50/50 chance of winning or losing 1000, and insurance costs 100. For what values of starting wealth W would you buy the insurance, and for what values of starting wealth W would you decline to buy the insurance ? 3. Suppose you are exposed to a situation where you have a 50/50 chance of winning or losing 10% of your wealth. Approximately what Cost 15 a percentage of the wealth insured, for the investor to be indifferent between not taking insurance ? 4. Explain your answers in 2 and invoking the concepts of absolute and relative risk aversion. ( 30 words )
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