Suppose that your wealth is 250,000. You buy a 200,000 house and invest the remainder in a risk-free asset paying an annual interest rate of 6%. There is a probability of 0.001 that your house will burn to the ground and its value will be reduced to zero. You have a log

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utility of end-of-year wealth (U(W) = log(W)). Assume that if the house does not burn down, its end-of-year value still will be 200,000.

1. (2 points) How much would you be willing to pay for insurance (at the beginning of the year)?

1. (2 points) If the cost of insuring your house is 1 per 1000 of value, what will be the certainty equivalent of your end-of-year wealth if you insure your house at 0.5 times its value?

An individual has expected utility of the form E[U(W)] = E[e^bW], where Wis the individual's wealth level and b >0. The individual's wealth is normally distributed as N(W,²).

1. (3 points) What is this individual's certainty equivalent level of wealth?