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  • EC364 Seminar 1

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    Razvan Amsterdam
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    This document contains exercises related to game theory and decision making under risk and uncertainty. It includes 5 questions analyzing lotteries and gambles using expected value and expected utility calculations. Specifically, it asks the reader to: 1) Calculate expected values and utilities for two lotteries, 2) Show that the expected utility of the St. Petersburg paradox game is finite, 3) Analyze insurance and security system options to deal with risk to an asset, 4) Calculate expected values of betting on numbers and colors in roulette, and 5) Graphically show how risk loving behavior can be modeled with a convex utility function.

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    This document contains exercises related to game theory and decision making under risk and uncertainty. It includes 5 questions analyzing lotteries and gambles using expected value and expected utility calculations. Specifically, it asks the reader to: 1) Calculate expected values and utilities for two lotteries, 2) Show that the expected utility of the St. Petersburg paradox game is finite, 3) Analyze insurance and security system options to deal with risk to an asset, 4) Calculate expected values of betting on numbers and colors in roulette, and 5) Graphically show how risk loving behavior can be modeled with a convex utility function.

    Copyright:

    Attribution Non-Commercial (BY-NC)
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    9 views2 pages

    EC364 Seminar 1

    Uploaded by

    Razvan Amsterdam
    This document contains exercises related to game theory and decision making under risk and uncertainty. It includes 5 questions analyzing lotteries and gambles using expected value and expected utility calculations. Specifically, it asks the reader to: 1) Calculate expected values and utilities for two lotteries, 2) Show that the expected utility of the St. Petersburg paradox game is finite, 3) Analyze insurance and security system options to deal with risk to an asset, 4) Calculate expected values of betting on numbers and colors in roulette, and 5) Graphically show how risk loving behavior can be modeled with a convex utility function.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as DOC, PDF, TXT or read online from Scribd
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    Brighton Business School Walter W.

    Heering

    EC364: Game Theory in Finance and Business Seminar Exercises No. 1


    1. Consider the two lotteries L1 = { 100,0;0.25,0.75 } and L2 = { 25,25;0.25,0.75 } = { 25;1} , where the first one offers you a chance to win 100, while the second offers you a sure amount of 25. For both lotteries calculate the expected value, the expected utility and the certainty equivalent, given a Von Neumann-Morgenstern utility function u( x ) x . 2. Show that with the N/M utility function u( x ) x the expected utility of the St. Petersburg game is finite. Calculate the certainty equivalent. 3. Suppose you have a total wealth of 1,000,000. One of your assets is an old painting, worth 40,000. There is a risk of 10% that the picture may be stolen or otherwise irreparably damaged. Consider two possible measures to deal with the risk: (a) You can buy an insurance which would cover 95% of the potential loss. (b) You may invest in a security system which reduces the risk of having the painting stolen or damaged to 5%. How much would you be ready to pay at most for each of these two remedies, given that you are risk-neutral. Hint: Define the outcomes of all three options (insurance, security system, no action) in terms of appropriate lotteries! 4. In roulette there are 37 possible states of the word, numbered 0, 1, ,36. The numbers 1, ,36 are alternately coloured black and red. If the number you have put your stake on comes up, you end up with 36 times your stake, otherwise you loose it. I the colour you have put your stake on shows up you receive double your stake, otherwise you loose it. (a) What is the expected value of the game for a person who puts 1 on one of the numbers? (b) What is the expected value of the game for a person who puts 1 on colour? (c) How can the theory of rational decision cope with the fact that so many people play the game?

    5. Show graphically that risk loving can analytically be represented by a convex N/M utility function, e.g. u( x ) x 2 . Hint: Use the two lotteries in the first question as a yardstick!

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