Lecture 6: Budget Lines, Syndicates, Risky Jobs & Insurance
More Budget Lines:
1) Mean-Variance Utility (Financial Economics)
Budget Line: Find to
Slope: Rise Over Run
"Price of Risk"
O-Cost of Risk is return on your portfolio
Return on portfolio
Variance on Portfolio
Portfolio with risk of
Hold in stock & 40 in bond
What if... :
a) Find bundle
b) Financial reforms reduce volatility so SE & IE illustrate
Max willing to pay for this gamble?
Evalue (some would pay, some not)
Risk Averse - Avoid risk (insure)
Risk Lover - Casino, Binge
Risk Neutral - Statisticians
Averse: Diminishing e.g.
Certainty Equivalent: What amount hold with certainty gamble?
Max willing to pay
Max willing to pay even though
Syndicates: (investors working together to share the risk)
wealth (doing nothing)
Opportunity to invest . chance of good
chance of bad
b) Joining doesn't change the probability of outcomes
Risky Job getting hurt. Hospital
What is the lowest willing to accept?
Key Question - Higher return enough to compensate risk? No
c) What fraction of wealth to hold in which?
Says: Put in stock, in bond
What is Max WTP for insurance?
With Insurance Fee: Certainty equivalent
Fair insurance was
We gave of good and got good .
willing to pay is green budget line. How big of a shift would leave you in different from point of no insurance.