Question
Suppose the economy can be in one of the following three states: I, II, and III. It is known that each state can occur with
Suppose the economy can be in one of the following three states: I, II, and III. It is known that each state can occur with an equal probability. Consider security XYZ that is expected to yield a payoff of $10 in state I, $5 in state II, and $5 in state III at the end of one year. An analyst provides revised estimates of state probabilities and conjectures that states I, II, and III would occur with probabilities 0.25, 0.25, and 0.50, respectively. You believe that the analysts estimates are better than yours. What is the maximum price you would be willing to pay for the analyst report? For simplicity, please assume that you can trade only up to 100 shares of XYZ with that information.
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