1. Explain why risk-neutral people can make a profit off both risk-averse and ri

Question

1. Explain why risk-neutral people can make a profit off both risk-averse and risk-seeking people. You must use original numerical examples and EV equations to demonstrate demonstrate your answer.

2. Explain how a risk neutral person can profit from another risk neutral person when one person misperceives either the value of something, or the probability of something happening. You must use original numerical examples and EV equations to demonstrate demonstrate your answer.

3. If being risk neutral is so beneficial, why isn’t everyone risk neutral? Give an explanation.

Explanation / Answer

Person could ask to buy insurance - would rather pay extra small amount of money for certain, not lose a large sum with a very small probability. The risk neutral person, on average, makes a profit every year, but the risk averse loses. A person's utility of the expected value of a gamble could also make them risk-averse. Maybe they need $10 for a train ticket, and have $11 right now, would not want to make a $2 bet even if the chance of winning is 90%. If they lose, no trip! Again the risk averse loses Risk-loving behavior; for example, asomeone who bets for entertainment. Now the risk lover loses. People are not all risk neutral because everyone has unique circumstances, $5 today might mean more than tommorrow, when the rent is due. Use Bernoulli utility function, like a logarithmic function.

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