Prediction markets allow traders to bet on future events. One prediction market that is particularly active this season involves betting on the winner of the U.S. presidential election. Thus, for example, if one trader buys one share of "Obama to win" from another trader, then if Obama wins the election the seller pays 1 dollar to the buyer, and if Obama does not win the seller pays nothing; either way, the seller keeps the money paid by the buyer for the purchase of the share. (a) Leila is an expected utility maximizer with von Neumann-Morgenstern utility u(x) In(x + 1) and initial wealth 4. Leila believes that Obama will win with probability 1/2.
Prediction markets allow traders to bet on future events. One prediction market that is particularly active this season involves betting on the winner of the U.S. presidential election. Thus, for example, if one trader buys one share of "Obama to win" from another trader, then if Obama wins the election the seller pays 1 dollar to the buyer, and if Obama does not win the seller pays nothing; either way, the seller keeps the money paid by the buyer for the purchase of the share. (a) Leila is an expected utility maximizer with von Neumann-Morgenstern utility u(x) In(x + 1) and initial wealth 4. Leila believes that Obama will win with probability 1/2.
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Transcribed Image Text:Prediction markets allow traders to bet on future events. One prediction market that is
particularly active this season involves betting on the winner of the U.S. presidential election.
Thus, for example, if one trader buys one share of “Obama to win" from another trader,
then if Obama wins the election the seller pays 1 dollar to the buyer, and if Obama does not
win the seller pays nothing; either way, the seller keeps the money paid by the buyer for the
purchase of the share.
(a) Leila is an expected utility maximizer with von Neumann-Morgenstern utility u(x)
In(x + 1) and initial wealth 4. Leila believes that Obama will win with probability 1/2.
Find the highest price po at which she is willing to buy at least one share.
(b) How does pu compare to the lowest price ps at which Leila is willing to sell at least one
share? Are they same? Explain.
(c) Vadim is more risk averse than Leila. He also believes that Obama will win with prob-
ability 1/2. How does the highest price at which he is willing to buy at least one share
compare to pu (i.e. to the corresponding price for Leila)? Prove your answer.
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