Question

if the feasible payoffs associated with a decision are $1000 with probability 0.4 and $200 with probability 0.6, then the expected utility for this decision will be 0.4*U($1000) + 0.6*U(200). In order to compute the expected utility (so that alternatives can be compared), we would need a utility function. A commonly used risk-averse utility function is U(x) = 1 – exp(-x/R), where R is often a large number. For the above example, if R=1000, then the expected utility would be 0.4*U($1000) + 0.6*U(200) = 0.4*(1 – exp(-1000/1000)) + 0.6*(1 – exp(-200/1000)) = 0.4*(0.632) + 0.6*(0.181) = 0.361.

Given the utility function, what is the maximum amount of money you should be willing to pay to get the information regarding the market movement?

Answer 1