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As you know, utility functions incorporate a decision maker's attitude towards risk. Let's assume that the following utilities were assessed for Stephanie Parker.
x
u(x)
-$400
0
-$365
10
-$320
20
-$270
30
-$200
40
-$110
50
$0
60
$130
70
$300
80
$600
90
$800
95
$1,100
100
Use these utilities to answer the following questions.
a) What is the monetary certainty equivalent for the following gamble: gain $130 with probability 0.4, lose $320 with probability 0.6.
b) What is the risk premium in a)? Explain the concept of a risk premium in addition to calculating its value for a).
c) What probability P would make Stephanie become indifferent between getting $130 for sure or taking the following gamble?
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