Harley’s current wealth is $600, but there is a 0.25 probabilitythat he will lose $100....

Harley’s current wealth is $600, but there is a 0.25 probability that he will lose $100. Harley is risk neutral. He has an opportunity to buy insurance that would restore his $100 if he lost it.

A) Harley would be willing to pay more than $25 for this insurance.

B) Harley would be willing to pay at most $25 for this insurance.

C) Harley would pay at most an amount strictly less than $25 for this insurance.

D) Since Harley is risk neutral, he wouldn’t be willing to pay anything for this insurance.

E) Since Harley’s utility function is not specified, we can’t tell how much he would be willing to pay for this insurance.

Solutions

Expert Solution

Wealth = $ 600

Probability of losing $ 100 = 0.25

Expected loss = $ 100 + 0.25 = $ 25

Therefore, Harley would be willing to pay at most $ 25 for this insurance.

Option B.

Rahul Sunny answered 2 years ago

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