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What do you know about the certainty equivalent

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Question: A young couple has $30,000 (95% of their savings) to invest in either savings bonds or a real estate deal. The (zero coupon) savings bonds return $36,000 ($6,000 interest) in three years. The (completely liquid) real estate investment, after three years, is worth $56,000 if economic conditions are good (75% chance), and worth nothing ($0) if economic conditions are bad (25%). The couple decides to invest in the savings bonds.

a. What do you know about the certainty equivalent (for the couple) of the real estate investment? HINT - Make sure you understand the concept of certainty equivalence.

b. What would you do in these circumstances?

c. Give me an example of a different set of probabilities that would change your decision in b".

Reference no: EM132211351

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