Analyze the alternatives with utility function

Reference no: EM13114200

A utility function is called Linear-plus-exponential when it contains both linear and exponential terms. Nancy, a bettor, has a choice between the following three alternatives:

Alternative # A 37% chances to WIN $15,500
63% chances to LOSE $3,500
Alternative # B 26% chances to WIN $18,700
74% chances to LOSE $1,645
Alternative # C 21% chances to WIN $9,500
79% chances to WIN $2,055

Analyze the above alternatives with utility function U(x) = 0.0085x - 6.725(ln(x)), where x is total/net wealth:

a. If Nancy has $5,600, which alternative he should choose among A, B or C?
b. If Nancy has $8,900, which alternative he should choose among A, B or C?
c. If Nancy has $12,500, which alternative he should choose among A, B or C?

If the above utility function is changed to U(x) = 0.0019x - 0.96e-x/14578. Analyze the above alternatives with new utility function for part d, e and f:

d. With new utility function do part ‘a ‘
e. With new utility function do part ‘b‘
f. With new utility function do part ‘c‘
g. If utility function is U(x) = 1.27 - 0.48e-x/17458
(g-1) If Nancy is risk neutral, what will be your recommendation, Alternative A, B or C?
(g-2) If Nancy is not risk neutral, what will be your recommendation, Alternative A, B or C?
(g-3) Calculate Risk premium for Alternative A, B and C independently? Which alternative is giving low certainty value to Nancy?

Reference no: EM13114200

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