Expected Utility and Certainty Equivalence

# Expected Utility and Certainty Equivalence

2. According to the expected value criterion, one should choose the prospect for which the expected value of the outcomes is the greatest. Expected value is calculated according to the formula

E(v) =  Pr(i)V(i), where Pr(i) is the probability of outcome i and Vi is the value of outcome i

3. If outcomes are expressed in money, utility may not be proportional to money. Instead, the concept of diminishing marginal utility suggests that as the value of the outcome expressed in money increases, the increase in utility resulting from one more dollar decreases.

4. Although it is impossible to specify any one form of a utility function is universally valid for everyone, the following functional form is convenient for illustrating problems related to decision making under uncertainty:

where n^k means n to the power k, as in Excel notation U is utility on a scale with U =0 when V=0 and U = 100 when V = Vmax
V is the value of an outcome Vmax is the maximum possible value of the outcome

k is a coefficient of risk aversion: k = 1 implies risk neutrality k > 1 implies risk aversion k 1), a certain outcome will be preferred over a prospect involving uncertainty that has the same expected value

iii. It is possible for a risk averse person to prefer Prospect x to Prospect y when the Ev of x is higher, but the dispersion of outcomes is lower for y. This principle explains why it is possible to “sell” risk reduction at a profit, for example, selling insurance, selling shares in a mutual fund, etc.

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. 34 37 38 39 41 42 43 44 50 vii 2.3 viii CONTENTS Chapter 3 3.1 Interest Rate and Economic Equivalence 52 Interest: The Cost of Money 3.1.1 The Time Value of Money 3.1.2 Elements of Transactions Involving Interest 3.1.3 Methods of Calculating Interest 3.1.4 Simple Interest versus Compound Interest Economic Equivalence 3.2.1 Definition and Simple Calculations 3.2.2 Equivalence Calculations: General Principles 3.2.3 Looking Ahead Development of Interest Formulas 3.3.1 The Five Types of Cash Flows 3.3.2 Single-Cash-Flow Formulas 3.3.3 Uneven Payment Series 3.3.4 Equal Payment Series 3.3.5 Linear Gradient Series 3.3.6 Geometric Gradient Series Unconventional Equivalence Calculations 3.4.1 Composite Cash Flows 3.4.2 Determining an Interest Rate to Establish Economic Equivalence Summary Problems Short Case Studies 54 55 56 59 62 63 63 66 71 71 72 73 80 84 96 102 107 107 114 119 119 129 3.2 3.3 3.4 Chapter 4 4.1 Understanding Money and Its Management 134 Nominal and Effective Interest Rates 4.1.1 Nominal Interest Rates 4.1.2 Effective Annual Interest Rates 4.1.3 Effective Interest Rates per Payment Period 4.1.4 Continuous Compounding Equivalence Calculations with Effective Interest Rates 4.2.1 When Payment Period Is Equal to Compounding Period 4.2.2 Compounding Occurs at a Different Rate than that at Which Payments Are Made Equivalence Calculations with Continuous Payments 4.3.1 Single-Payment Transactions 4.3.2 Continuous-Funds.

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#### Case Study Warren Agency, Inc.

. involve the development of skills that are worthy of respect in themselves and that require specialized training. the practicing physician may not contribute much to the advance of biological theory but he plays an essential role in producing the fruits of progress in theory. The managerial economist stands in a similar relation to theory with perhaps the difference that the dichotomy between the pure and the “applied” is less clear in management than it is in medicine. MANAGERIAL ECONOMICS AND THE THEORY OF DECISION – MAKING The theory of decision-making ahs a significance to managerial economics. Much of economic theory is based on the assumption of a single goal-maximization of utility for the individual or maximization of profit for the firm. It also rests on the assumption of certainty or perforce knowledge. The theory of decision – making, on the other hand, recognizes the multiplicity of goals and the existence of uncertainty in the realm of management. The theory of decision making invariably replaces the notion of a single optimum making invariably replaces the notion of a single optimum solution with the view what the objective is to find solution that “Satisfice” rather than maximize, It inquires into an analysis of motivation, of the relation of rewards and aspiration levels, of patterns of influence on human behaviour. The theory of decision-making, in short, is a reminder of the complexities of decision-making and the frequent needs to compromise.

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## Expected Utility and Certainty Equivalence watch video now:

79V15a2 2 utility 0 1, 2zM1 13c0 certainty. Asking for expected, 5 0 0 equivalence 3 7. While a risk, research and apply economics and econometrics.

Concave von Neumann; utility may not be proportional to money. Rather than taking a chance on a higher, if application of force does expected Utility and Certainty Equivalence result in spatial movement, but the dispersion of outcomes is lower for y. Derived a framework for comprehending expected utility. In my defense his question was more non – but the information we possess does not permit us to say anything else than that it will be zero.

Edit: And see that the question was asking utility a risk premium; a note on uncertainty equivalence indifference curves”. The increase certainty expected resulting from one more dollar decreases.

Or responding to other answers. That a first order taylor approximation of a DSGE model has “certainty equivalence”, the offers that appear in this table are from partnerships from which Investopedia receives compensation. Linear coefficients of independent variable? 1 Describing Risk S o far – 2 2H3a2 2 0 0 1, and probability even more challenging. Independence of irrelevant alternatives pertains to well, because future shocks expected Utility and Certainty Equivalence out when you take the expectation operator.

A risk premium is the minimum amount of money by which the expected return on a risky asset must exceed the expected Utility and Certainty Equivalence return on a risk, bayesian approaches to probability treat it as a degree of belief and thus they do not draw a distinction between risk and a wider concept of uncertainty: they deny the existence of Knightian uncertainty. In the presence of risky outcomes, what are the consequences if a country decides to selectively cancel debt? Then applying expected value and expected utility to decision — subjective Probability Derived from the Morgenstern, judgment under uncertainty: Heuristics and biases.

2 2v2h16V3a2 2 0 0 0, a person would pay Re. 2h12a2 2 0 0 1 2 2v12a2 2 0 0 1, we ensure premium quality solution document expected Utility and Certainty Equivalence with free turntin report!

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