Consider a game in which a coin will be flipped three times. For each heads you

Question

Consider a game in which a coin will be flipped three times. For each heads you will be paid $100. Assume that the coin comes up heads with probability 3/5.

a. Construct a table of the possibilities and probabilities in this game.

b. Compute the expected value of the game.

       

    The expected value of the game is $.

c. How much would you be willing to pay to play this game?

       

    A person who is risk averse will want to pay less than $; a person who is risk-neutral will be willing to pay $.

d. Consider the effect of a change in the game so that if tails comes up two times in a row, you get nothing. How would your answers to the first three parts of this question change?

Expected value = $

A person who is risk-averse will want to pay less than $; a person who is risk- neutral will be willing to pay $.

Possibilities Probability Outcome 1 / 0 heads, 3 tails 2 / 1 head, 2 tails 3 / 2 heads, 1 tail 4 / 3 heads, 0 tails

Explanation / Answer

Risk averse pay less than 180,

Risk neutral willing to pay 180

Possibilities Probablities Outcomes Payoff Expected value 1 0.064 0 heads, 3 tails 0 0 2 0.288 1 head, 2 head 100 28.8 3 0.432 2 head, 1 tail 200 86.4 4 0.216 3 head, 0 tails 300 64.8 1 180

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