You own a house that is valued at $500,000. The probability of ahouse 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. Suppose you are a risk-neutral person, what would be the most you are willing to pay for the insurance that pays you $300,000 in case of fire. Please explain your answer.

Solutions

Expert Solution

for risk neutral :

maximum amount willing to pay = (payment by insurance company)*P(fire)

= $300,000 * 0.0002

= $60

The most a risk-neutral person, would be willing to pay for the insurance = $60

orchestra answered 1 year ago

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