-Adriana wants to try working as an independent contractor this summer. She has a 50 percent chance that she will make $9,000 and 50 percent chance that she will make nothing. Her utility of wealth curve is shown in the figure above. What's Adriana's cost of risk?
A) $2,500
B) $2,000
C) zero
D) $40

Question

-Adriana wants to try working as an independent contractor this summer. She has a 50 percent chance that she will make $9,000 and 50 percent chance that she will make nothing. Her utility of wealth curve is shown in the figure above. What's Adriana's cost of risk?
A) $2,500 
B) $2,000 
C) zero 
D) $40

Quizplus · Accepted Answer

Adriana's expected income is $4,500 (0.5 * $9,000 + 0.5 * $0). Her utility of $4,500 is 0.8. Her utility of $9,000 is 0.95. The cost of risk is the difference between the utility of the expected income and the expected utility of the risky income. The expected utility of the risky income is 0.5 * 0.95 + 0.5 * 0 = 0.475. The cost of risk is 0.8 - 0.475 = $2,500.

-Adriana Wants to Try Working as an Independent Contractor This