Question

For each of the following scenarios, determine whether the decision maker is risk neutral, risk averse, or risk loving.

a. A manager prefers a $20$percent chance of receiving $\cancel{S}1,400$and an $80$percent chance of receivingto receivingfor sure.

b. A shareholder prefers receiving$\cancel{S}920$with certainty to an$80$percent chance of receiving$\cancel{S}1,100$and a$20$percent chance of receiving$\cancel{S}200$.

c. A consumer is indifferent between receiving$\cancel{S}1,360$for sure and a lottery that pays$\cancel{S}2000$with a$60$percent probability and$\cancel{S}400$with a$40$percent probability.

Short answer

a. The manager that prefers a 20% chance of receiving $\cancel{S}1,400$and an 80% chance of receiving $\cancel{S}500$to receiving $\cancel{S}680$for sure is risk loving.

b. A shareholder that prefers receiving $\cancel{S}920$with certainty to an 80% chance of receiving $\cancel{S}1,100$and a 20% chance of receiving role="math" localid="1653563709305" $\cancel{S}200$is risk averse.

c. A consumer that is indifferent between receiving $\cancel{S}1,360$for sure and a lottery that pays $\cancel{S}2000$with a 60% probability and $\cancel{S}400$with a 40% probability is risk neutral.

Step-by-step solution

Concept Introduction

There may be different risk profiles in which the investor may be willing to take the risk or avoid the uncertainty that a financial investment may generate. There are three different types of attitudes when making a decision –

Risk averse: Risk averse people are more mind-blocked who prefer to make a decision that assures them an amount of money than to risk a possible amount that may be higher.

Risk loving: Risk loving people bear a higher level of risk and uncertainty. They prefer to take a risk with an expected value than tohave a safe amount of money.

Risk neutral: Risk neutral people are indifferent between making a risky decision or a decision that provides it with a safe amount of money.

Determining the category of Decision Maker

In this option, the manager has a profile of risk loving by preferring an option with a lower percentage of occurrence $\left(20\%\right)$but with a higher profit and of having a lower profit.

Therefore, the result is obtained as risk loving.

Determining the category of Decision Maker

a.

The shareholder has a risk aversion attitude. The shareholder prefers the option of getting $920 as this option has 80% success rate. This person avoids a $20\%$probability of obtaining $\cancel{S}200$.certainly

Therefore, the result is obtained as risk averse.

Determining the category of Decision Maker

a.

In this case, the consumer’ risk is neutral. This person does not care having $\cancel{S}1,360$for sure than betting in the lottery that pays $\cancel{S}2000$with a$60\%$ probability and$\cancel{S}400$ with a$40\%$ probability.

Therefore, the result is obtained as risk neutral.