Uncertainty (L6)

Question 1

lottery

Answer 1

(possible outcome, probability of getting outcome; second outcome, probability 2)

Question 2

expected value

Answer 2

outcome x probability

Question 3

expected utility

Answer 3

utility x outcome used when you can’t repeat the utility often (large gambles)
sub in outcome value into utility function

Question 4

mixed lotteries

Answer 4

looking at the lotteries instead, given two different options which will give different outcomes, showing all outcomes from both lotteries

Question 5

risk averse

Answer 5

doesn’t like risk
EV(l),1>_ l
would rather get sure amount than gamble
concave (upside down)
EU(l) <_ u(EV(l))

Question 6

risk neutral

Answer 6

indifferent
l ~ EV(l),1
linear

Question 7

risk seeking

Answer 7

l >_ EV(l),1 prefers lottery over sure result
convex

Question 8

how to find u(EV(l))

Answer 8

sub EV into utility function

Question 9

certainty equivalent

Answer 9

CE(l) the amount they get for sure that means they’d rather receive x amount than play the lottery
u(CE(l))=EU(l) expected utility must equal utility after loss

Question 10

risk averse certainty equivalent

Answer 10

CE<_ EV(l)

Question 11

risk loving certainty equivalent

Answer 11

CE>_EV(l)

Question 12

risk premium

Answer 12

difference between expected value and certainty
RP(l)= EV(l) - CE(l)
how much they are willing to pay over the expected loss

Question 13

risk premium when risk averse

Answer 13

RP(l) >_0

Question 14

risk premium when risk loving

Answer 14

RP(l) <_ 0

Question 15

WTP

Answer 15

willingness to pay
W-CE(l)= W- (EV(l)-RP(l)

Question 16

expected loss

Answer 16

W-EV(l)

Question 17

Certainty

Answer 17

u(CE)=EU
rearrange