chapter 11 question 1 and 14 1. why does the assumption of independence of risks matter in the examples of insurance? What would happen to premiums if the probabilities of houses burning were...

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chapter 11 question 1 and 14

1. why does the assumption of independence of risks matter in the examples of insurance? What would happen to premiums if the probabilities of houses burning were positively correlated? Can you think of a situation where they might be negatively correlated?

14. Small firms can discover the abilities of their workers more quickly than large ones because they can observe the workers more closely at a variety of tasks. does it then make sense for people with high abilities to go to small firms? give some reason why and some reasons why not.

chapter 12

4. in some ways monitoring is easier in a partnership than a corportion, where shareholders monitor directors. In what ways is monitoring easier and what ways its not.

11. A friend convines you that she has a great idea for a business and the two of you incorporate. you supply her with funds and let her make all of the executive decisions. under the agreement you hold 30 percent of the firms stock and your friend holds 70 percent. Why should you ever put yourself into a position where your friends decision will carry the day whether you agree with her or not? what does this tell you abount problems that allegedly stem from seperation of ownership and control?

Answered Same DayDec 20, 2021

Solution

David answered on Dec 20 2021
3 Votes
Chapter 11 question 1 and 14 1. Why does the assumption of independence of risks matter in the examples of insurance? What would happen to premiums if the probabilities of houses burning were positively co
elated? Can you think of a situation where they might be negatively co
elated?
Answer:
The assumption of independence of risks matter in the example of insurance because in opposite to risk-neutral parties, the risk adverse parties are not only concerned about the expected value of losses but also concerned about its magnitude. Hence, for example risk-averse parties will face a situation having 5% chance of losing 40,000 which is worse than a situation having 10% chance of losing 20,000 and in turn both the situations will have same expected loss of 2,000. Risk-neutral parties would not have any one of the situations more risky than the other. In other words, risk adverse parties will not like the uncertainty about the size of loss. The assumption about risk adverse party appears to be equal to simple assumption related to utility of the party attached to his wealth. Suppose that the utility of the party increases with the wealth level, it increases at the decreasing rate. It should be plausible the party for whom the graph is shaped will dislike because of chance of large losses, such losses will be disproportionate to the utility. In short, a party assumes its risk prospect by...
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