Risk assessment, Risk Management

Scottie is a professional basketball player who plans to play for three more years.  During the summer, he has been offered two different contracts by his current team.  The first is a three-year guaranteed contract (meaning he gets paid even if he is injured or cut from the team) that would pay him $5 million per year.  The second contract is a one-year guaranteed contract that would pay him $3 million, after which he could become a "free agent" and negotiate his next contract with any team in the league.  Scottie, being a good business person, has commissioned a detailed statistical study of past basketball performances by similar players, and concluded that, if he accepts the one-year contract:

i.    There is a 25% chance that he will be injured during the upcoming season and will never play again; and

ii.   There is a 75% chance that he will play well enough this upcoming year to receive a two-year guaranteed contract for $7 million per year.

Scottie decides to accept the one-year contract.

a. What do you know about his risk preferences, given the choice that he has made?  Explain how you know this both in words and by using a utility of wealth graph similar to the one used in class.

b. What can you say for sure about the relative magnitude of Scottie's certainty equivalent?

Posted Date: 2/25/2013 2:13:24 AM | Location : United States

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