We are planning for the investment portfolio for a new customer of our consultan

Question

We are planning for the investment portfolio for a new customer of our consultancy firm Analyzing the past investments of the customer. we observed that the utility function is of the type max -min where rmax- 100 is the maximum considered revenue and rmin-0 is the minimum revenue. Answer the following questions: 1. What type of decision maker are we dealing with (risk averse, risk prone,risk neutral? 2. What is the RP coefficient for this decision maker? 3. What is the maximum price at which we can sell the option in Eigure 1 to our customer? 100 Poure 1: Option eoposed to the etom

Explanation / Answer

1. Clearly the utility function is concave, hence it is risk averse

2. RP= -XU''/U'

        = -X * 0.5 * -0.5 * X-3/2 / 0.5*X-1/2

           = 0.5

3. E(X)= 0.5*100 + 0.5*0 = 50

E(U(X))= 0.5*1 + 0.5*0= 0.5

0.5 corresponds to X=25

Hence the customer is willing to pay 25.

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