Show and explain why risk averse individuals will generally refuse actuarially fair bets and purchase insurance that allows them to avoid participating in fair bets.

The first 200 words of this essay...

Question 3:

(i). Show and explain why risk averse individuals will generally refuse actuarially fair bets and purchase insurance that allows them to avoid participating in fair bets.

(ii). Discuss some of the problems that have beset the von Neumann-Morgenstern model of choice under uncertainty.

(i)

There are three possible attitudes to risk: risk averse, risk neutral and risk loving. Each of these attitudes to the outcome of an uncertain activity are different. If an individual is risk averse then he will only accept a gamble if the expected monetary value (EMV) of said gamble is greater than the certain monetary equivalent (CME). In other words if this individual was given the choice of a certain amount of money guaranteed and a risky game that would yield the same expected return, this individual would choose the guaranteed sum of money (or CME), since he prefers to avoid risk. It follows that a risk neutral individual is indifferent between such a gamble and a guaranteed amount of money, if CME equals EMV, and a risk lover requires CME to be greater than EMV not to accept the gamble.

If indifference curves are drawn for these