Devon’s utility function is represented by U(w)=2(w1/2) . Devon has just purchased a new home worth...

Devon’s utility function is represented by U(w)=2(w^1/2) . Devon has just purchased a new home worth $100,000 and his home represents all of his wealth. The statistics show that in any year there is a two percent (0.02) chance that his home may burn down. If Devon’s house does burn down then the value of the scraps is $30,000.

Using the information above draw Devon’s utility function, plot utility against wealth)
Is Devon risk averse? Explain
The insurance for the house costs 2.5 cents per dollar insured, based on Devon’s preferences how much insurance will he buy?
Devon’s brother also owns a house that is valued at $100,000. His brothers house also has a 2% risk of burning down, if this occurs then the value of the scrap is worth $30,000. Determine the expected utility for Devon if the two brothers share the losses equally. Also assume that the event of both houses burning down are independent.

Solutions

Expert Solution

the term risk -averse describes the investor who chooses the prevention of capital over the potential for a higher-than-average return.

In investing ,risk equals price volatility.A volatile investment can make you rich or devour your savings .A conservative investment will grow slowly and steadily over time.

Low-risk means stability .A low risk investment guarantees a reasonable if unspectacular returnwith a near -zero chance that any of the orginal investment will be lost.

Rahul Sunny answered 2 years ago

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