Consider a risk averse individual who has utility function u(a) which is increasing with u(0) = 0. There are two risky assets: A,B. For A, every dollar invested gives return $0 with probability 1/3 and $3 with probability 2/3. For B, every dollar invested gives return is $0 with probability 1/4 and $3 with probability 3/4. The individual has $120 to invest. Consider two investment choices: (1) invest entire $120 in A and (2) invest $60 in A, $60 in B. (a) Drawing diagram of the utility function and showing your work, determine
Consider a risk averse individual who has utility function u(a) which is increasing with u(0) = 0. There are two risky assets: A,B. For A, every dollar invested gives return $0 with probability 1/3 and $3 with probability 2/3. For B, every dollar invested gives return is $0 with probability 1/4 and $3 with probability 3/4. The individual has $120 to invest. Consider two investment choices:
(1) invest entire $120 in A and
(2) invest $60 in A, $60 in B.
(a) Drawing diagram of the utility function and showing your work, determine the expected utility of the individual from choice 1.
(b)Drawing diagram of the utility function and showing your work, determine the expected utility of the individual from choice 2 when return from A is bad.
(c) Drawing diagram of the utility function and showing your work, determine the expected utility of the individual from choice 2 when return from A is good.
(d) Drawing diagram of the utility function and showing your work, determine the expected utility of the individual from choice 2.
(e) Comparing expected utility from choices 1,2 in a diagram, determine which choice is better.
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