Given the following lottery x,
Payoff 0 4 9 12 14 20
Probability 0.05 0.2 0.25 0.25 0.2 0.05
1a) Compute the certain equivalent C such that U(C)= E[U(x)] (i.e. the amount of
money that makes the investor indifferent between receiving it with certainty or
playing the lottery) for an investor with negative exponential utility function
U(W)= 1-exp(-c W) with c=0.2 .
1b) Compute the risk premium as π = E(x) – C and verify the approximation
where A(W)= -U’’(W)/U’(W) is the absolute measure of risk aversion of the investor.
1c) Show how the risk premium varies as the parameter c changes.
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