A risk averse individual is offered a choice between getting $400 for sure and entering a...

A risk averse individual is offered a choice between getting $400 for sure and entering a gamble that promises a gain of $1000 with probability 0.25 and a gain of $300 with probability 0.75. Given this situation, he or she will

definitely take the gamble
definitely not take the gamble
definitely take the gamble if his or her income is high enough
take an action that cannot be determined without specifying the individual’s utility function

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Expert Solution

Ans.

Correct Option is - D.

Guaratee money =$400

Expected Value of Lottery = 1000 x 0.25 + 300 x 0.75

= 250 + 225 = $475

Risk Premium = $475 - $400 = $75

We see that expected return is $75 more than the sure money of $400 , This return might or might not be accepted by the person , because to know how much of a risk averse person is he ,which can be measured by the utility function of this individual.

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Rahul Sunny answered 2 years ago

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