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Imagine that you face the following pair of concurrent decisions. First examine both decisions, then indicate the options you prefer:
Decision (i) Choose between
Decision (ii) Choose between:
Indicate which option you would choose in each of the decisions and why.This problem has been adopted from D. Kahneman and D. Lovallo, “Timid Choices and Bold Forecasts: A Cognitive Perspective on Risk Taking,” Management Science 39, no. 1 (1993): 17–31.
Consider the following two lotteries:
Which of these lotteries will you prefer to play?
Now, assume somebody promises you sure sums of money so as to induce you to not play the lotteries. What is the sure sum of money you will be willing to accept in case of each lottery: a or b? Is your decision “rational”?
Partial insurance:Challenging problem. This problem is designed to illustrate why partial insurance (i.e., a policy that includes deductibles and coinsurance) may be optimal for a risk-averse individual.
Suppose Marco has an initial wealth of $1,000 and a utility function given by $U(W)=\sqrt{W}$ . He faces the following loss distribution:
Prob | Loss |
---|---|
0.9 | 0 |
0.1 | 500 |
Suppose a coin is tossed twice in a row. The payoffs associated with the outcomes are
Outcome | Win (+) or loss (−) |
---|---|
H-H | +15 |
H-T | +9 |
T-H | −6 |
T-T | −12 |
If the coin is unbiased, what is the fair value of the gamble?
If you apply the principle of framing to put a favorable spin to events in your life, how would you value the following gains or losses?