Option A has an expected value of $2,000, a minimum payoff of -$4,000, and a max

Question

Option A has an expected value of $2,000, a minimum payoff of -$4,000, and a maximum payoff of $18,000. Option B has an expected value of $2,200, a minimum payoff of -$1,000, and a maximum payoff of $6,000. Option C has an expected value of $1,900, a minimum payoff of $100, and a maximum payoff of $2,000. In this situation, a risk-averse decision maker would "pay" __________ for his risk aversion, and a risk-seeking decision maker would "pay" __________ for his risk seeking. Hint: Compare them to a risk neutral decision.

Explanation / Answer

A risk averse decision maker would look at the most likely outcome

So the decision maker should take the expected value of each option, hence the max expected payoff is of Option B.

So the extra loss in max payoff is what he pays for risk aversion = 18000-6000 = 12000

For a risk seeking he might lose more and that is what he pays, for a risk seeker best option is A as he would seek the max payoff only .

He would pay -1000- -4000 = 3000 , for his risk seeking

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