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Suppose that Ron has initial wealth w = 900. He is faced with the choice about whether to invest in a new startup, which he
Suppose that Ron has initial wealth w = 900. He is faced with the choice about whether to invest in a new startup, which he has estimated may result in one of four possible results. With probability 0.2 he will lose 600; with probability 0.25, he will lose 280; with probability 0.4, he will make 360; and with probability 0.15, he will make 940. The possible consequences of investing in the startup can be represented as a lottery P. (with the outcomes representing changes to his initial wealth) where P = (0.2. -600; 0.25. - 280: 0.4, +360; 0.15.-940) (a) Calculate the expected value of Ron's final wealth, i.e. Elw+P). (1 point) (b) Suppose Ron is a risk averse expected utility maximizer, with Bernoulli utility function u(w) = w4 Calculate his certainty equivalent CE, and his risk premium RP for lottery P, and explain whether or not he should choose to invest in the startup (3 points) (c) Now suppose Ron's initial wealth were to decrease to some
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