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Could u give a small hint?
On Tue, Jun 19, 2012 at 9:23 PM, Amit Goyal [via Discussion forum] <[hidden email]> wrote: June20__Uncertainty.png |
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E(Y+Z)=E(Y)+E(E(Z|Y))=E(Y)+0. so the expected values of both r equal. every risk averse individual would prefer Y to Y+Z coz they wont take additional risk if the expected value isnt increasing. risk neutral people would be indifferent. and risk loving people would prefer Y+Z. this means only statement 2 is correct.
i know this is wrong. in fact i think the first step is wrong. |
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Sure. For understanding, lets do the problem for the finite state space or sample space i.e. S = {s(1), s(2), ..., s(n)}. Y takes only two values y(1) and y(2) i.e. Y: S --> {y(1), y(2)}. And its given that Z is another random variable Z: S --> R. It is also given that Pr(Y = y(1)) = pi(1) and Pr(Y = y(2)) = pi(2). And we know that E(Z|Y) = 0.
We can think of Y and Y + Z as two lotteries or gambles. The question asks you that if an individual has to choose between the two which one will he pick depending on his attitude towards risk? |
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Hmm..so is what I did completely wrong?
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In reply to this post by Amit Goyal
(iii) and (iv)
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In reply to this post by Amit Goyal
I am getting same answers as vasudha..
expected returns of both are same. and risk in Y+Z is more.. So, just 2nd is true. |
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This post was updated on Jun 20, 2012; 5:59am.
In reply to this post by anon_econ
Hi Vasudha and AJ,
Your conclusion is correct and I could also see that you have right reasons in mind. The only thing that is missing is the convincing expressions. Here is how you prove it: Given that the person is risk averse, his utility function for money will be a concave function. Eu(Y + Z) = E(Eu(Y + Z)|Y) = pi(1) Eu((Y + Z)|Y = y(1)) + pi(2) Eu((Y + Z)|Y = y(2)) = pi(1) Eu((y(1) + Z)|Y = y(1)) + pi(2) Eu((y(2) + Z)|Y = y(2)) ≤ pi(1) u(E(y(1) + Z)|Y = y(1)) + pi(2) u(E(y(2) + Z)|Y = y(2)) [By concavity of u(.)] = pi(1) u(y(1)) + pi(2) u(y(2)) [E(Z|Y = y(1)) = 0 and E(Z|Y = y(2)) = 0] = Eu(Y) This automatically disproves (iii), (iv) and (v). For (i), just construct an example. As you said a risk loving person with appropriate choice of state space, pi, lotteries and utilities would do. |
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I see :-)
On Wed, Jun 20, 2012 at 5:53 AM, Amit Goyal [via Discussion forum] <[hidden email]> wrote: Hi Vasudha, ... [show rest of quote] |
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