Question

You play a coin flip game where you win NOTHING if the coin comes up heads or win $1,000 if the coin comes up tails. Assume a fair coin is used. Which of the following is TRUE?

Group of answer choices

a. A risk-seeking person would be willing to accept a cash payment of $500 to forgo (i.e. pass up) playing the game.

b. A risk neutral person might accept a cash payment of $400 to forgo (i.e. pass up) playing the game

c. The expected value of playing this game is winning $1,000.

d. A risk-averse person might accept $400 in cash to forgo (i.e. pass up) playing the game

Answer 1

In the event of winning heads, Outcome = $ 1000

Event of winning tails , Outcome = $ 0

Probability of heads = 0.5 , Probability of tails = 0.5

Expected outcome = 0.5* 1000 + 0.5* 0 = $ 500

A risk averse person might be willing to accept a certainty equivalent less than the expected outcome inorder to forego playing the game. So he/she might accept the $ 400 in cash to forego playing the game.

Answer is d. A risk-averse person might accept $400 in cash to forgo (i.e. pass up) playing the game