Suppose your current wealth (W) is $10,000. Suppose you are offered a gamble where you can win $4000 with one-half chance but you can lose $4000 with one half-chance. Suppose your utility function is defined as U(W) = W^0.5. (The square root of your wealth). To you, the Certainty Equivalent (CE) of this gamble is approximately:
A) 9582.5.
B) 100.00.
C) 10,000.
D) 417.6.

Question

Quizplus · Accepted Answer

The expected utility of the gamble is 0.5 * (sqrt(14000)) + 0.5 * (sqrt(6000)). The CE is the wealth level that gives the same utility as the expected utility of the gamble, which is approximately 9582.5.

Suppose Your Current Wealth (W) Is $10,000