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You own a lottery ticket, which has a 1 percent chance (0.01) of winning $1,000. Someone...

You own a lottery ticket, which has a 1 percent chance (0.01) of winning $1,000.

  1. Someone has offered you 12 dollars to buy this ticket and you refused, what does that indicate in terms of your risk preference (i.e. risk-averse, risk-neutral or risk-loving)? Explain (simple calculations will be needed).
  2. Afterward, your friend Jennifer commented: “You should have accepted that offer. I would sell the ticket for 9 dollars!” What does that comment indicate in terms of Jennifer’s risk preference? Explain (simple calculations will be needed).
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Answer #1

Expected value from lottery ticket = 0.01(1000) + 0.99(0)

Expected value of lottery ticket = $10

A)

Expected value = $10

Offered value = $12

Since the individual prefered keeping the ticket having an expected value lower than the money offered in return, it means the individual is risk loving

B)

Expected value = $10

Money Jennifer would accept = $9

This means Jennifer is risk averse, as she prefers a sure shot money which is lower than the expected value of the lottery.

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