Chapter 6 "Risk and risk aversion" presents the following content: Risk - uncertain outcomes, risky investments with risk-free, risk aversion & utility, dominance principle, utility and indifference curves,. | CHAPTER 6 RISK AND RISK AVERSION 1 RISK AND RISK AVERSION Risk with Simple Prospects Risk, Speculation, and Gambling Risk Aversion and Utility Values 2 Risk with Simple Prospects The presence of risk means that more than one outcome is possible. A simple prospect is an investment opportunity in which a certain initial wealth is placed at risk, and there are only two possible outcomes. For the sake of simplicity, it is useful to elucidate some basic concepts using simple prospects. 3 Risk with Simple Prospects Take as an example initial wealth, W, of $100,000, and assume two possible results. With a probability p = .6, the favorable outcome will occur, leading to final wealth W1 = $150,000. Otherwise, with probability 1 – p = .4, a less favorable outcome, W2 = $80,000, will occur. 4 Risk with Simple Prospects We can represent the simple prospect using an event tree: p = .6 W1 = $150,000 W = $100,000 1 – p = .4 W2 = .
