You own a house that is valued at $500,000. The probability of a house fire in...

You own a house that is valued at $500,000. The probability of a house fire in your area is 0.0002, and if a house fire happens, your home’s value will be reduced to $0. You are considering buying an insurance for your house. In case of fire, the insurance company will pay you $300,000. Ignore depreciation, taxes, etc. of your house in the following calculations. What is the expected values of your home without insurance and your home if the insurance is free?

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Expert Solution

Solution:

The expected value of your home without insurance is:

Therefore, the expected value of your home without insurance is -$100

The expected value of your home with free insurance is:

Therefore, the expected value of your home with free insurance is $60

orchestra answered 1 year ago

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