Do the absolute magnitudes of the monetary outcomes matter in the risky venture example? Consider the following two possibilities. In each case, multiply all monetary values in the example by a factor...

Do the absolute magnitudes of the monetary outcomes matter in the risky venture example? Consider the following two possibilities. In each case, multiply all monetary values in the example by a factor of A. (For example, double them if A =2.) For each part, briefly explain your findings.

a.   Currently, an EMV-maximizer would choose the most risky venture. Would this continue to be the case for any factor A?


b.   Currently, an expected utility maximizer with risk tolerance $1.92 million prefers the riskless alternative. Would this continue to be the case for any factor A greater than 1? What about when A is less than 1? You can answer by using trial and error on A. c. Referring to the dialog box in Figure 10.43, there is a display dropdown with three options: expected value (EMV), expected utility, and certainty equivalent. The latter is defined for any gamble as the

sure monetary amount a risk averse person would take as a trade for the risky gamble. For example, you can check that the certainty equivalent for the more risky alternative is 86.2017 (in thousands of dollars). Explain what this really means by calculating the utility of 86.2017 manually and comparing it to the expected utility from the more risky venture (as shown on the tree). How does this explain why the decision maker prefers the riskless alternative to the more risky venture? How does this certainty equivalent change when A=2? Discuss whether this change goes in the direction you would expect.

Figure 10.43