An investor has the opportunity to buy one of four different stocks. Each stock
ID: 1169377 • Letter: A
Question
An investor has the opportunity to buy one of four different stocks. Each stock is currently selling for $50 per share, and the investor will purchase 20 shares of one of the stocks and sell them one year later. If there is a recession (state 1) the selling prices will be $40, $52, $58, and $45. If there is no recession, the selling prices will be $53, $56, $54, and $60. Complete the payoff table and opportunity loss table below.
Payoff Table
Alternatives
State 1
State 2
Stock 1
Stock 2
Stock 3
Stock 4
Opportunity Loss Table
Alternatives
State 1
State 2
Stock 1
Stock 2
Stock 3
Stock 4
a. Are any of the stocks clearly inferior choices? (Explain. You can eliminate any inferior choice(s) from the rest of the analysis).
b.What is the alternative chosen using the optimistic (maximax) criterion?
c.What is the alternative chosen using the pessimistic (minimax) criterion?
d.What is the alternative chosen using the minimax regret criterion?
Over the past 40 years, the probability of any given year being a recessionary year is 0.1. Given this information,
e.Calculate the expected monetary value (EMV) for each stock. Which stock would an EMV maximizer choose?
f.Calculate the EVPI (that is, how much the investor should be willing to pay an economist (or a psychic) to tell him, with certainty, next year’s state of nature).
Payoff Table
Alternatives
State 1
State 2
Stock 1
Stock 2
Stock 3
Stock 4
Explanation / Answer
a.
the inferior choice is state 1 since, state 2 is positive stock of return while state 1is negative return of stock.
b.
under maximax selection stock 4 should be selected due to highest yielding stock.
.
c.
Minimum regret is for stock 2 and should be selected.
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.