Reminder: You should feel free to discuss the problems with your fellow students, and in fact are
encouraged to do so. However, after discussing the problems, you must write out your answers on
your own. Directly copying someone else’s problem set will be considered cheating.
You have plenty of time to complete this problem set, and so I will expect your answers to be
clear
and
concise
. It is suggested that you fifirst work out your answers on scratch paper, and then write
up (or type up) your answers in a manner that clearly identififies how to solve the problem while
not including any extraneous information or discussions.
Question 2
Consider a choice between lottery
(
)
and lottery
(
1)
, where
∈
(0
1)
and
= 0
.
(a)
Alice is a risk-averse EU maximizer. How does her choice depend on
and
?
(b)
Wally evaluates gambles according to prospect theory – and in particular has a value function
and a probability-weighting function with the properties suggested by Kahneman & Tversky (1979).
How does his choice depend on
and
?
Note: You need not provide precise mathematical analyses–rather, it is su
ffiffiffi
cient to provide an
intuitive discussion of Alice’s and Wally’s behavior, and how their behavior depends on
and
.
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