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Adam paid $200 for a lottery ticket which will pay $20,000 with probability of 1%. Adam...

Adam paid $200 for a lottery ticket which will pay $20,000 with probability of 1%. Adam needs some cash today to buy the BUS 771 textbook before the upcoming exam. Bernice offers him $150 for the ticket. Adam rejects her offer. Charlie offers him $250 for the ticket. Adam accepts this offer. What can we say about the risk preferences of Adam (A), Bernice (B) and Charlie (C)? (Assume that there is no intertemporal discounting, so money today is worth the same as money at some time in the future).

a. Bernice is more risk loving than Adam, but more risk averse than Charlie.
b. We can say nothing about their risk preference given the information in the problem.
c. Adam is risk loving, but neither Bernice nor Charlie are risk loving.
d. All three are risk neutral.
e. Bernice is more risk averse than Adam; Adam is more risk averse than Charlie
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Answer #1

Correct option: (e) Bernie is more risk averse than Adam; Adam is more risk averse than Charlie

Reason: Expected value of lottery = 1% of 20,000 = $200

Bernie values it at $150

Adam values it at $200

Charlie values it at $250

This means,

Charlie is most risk loving

Bernie is risk averse

Adam lies between them both as he is risk neutral

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