Question 2. Bob has an initial wealth of W; however, with probability n he suffers a loss of D and his wealth drops to W

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Question 2 Bob Has An Initial Wealth Of W However With Probability N He Suffers A Loss Of D And His Wealth Drops To W 1 (54.33 KiB) Viewed 39 times

Question 2. Bob has an initial wealth of W; however, with probability n he suffers a loss of D and his wealth drops to W-D. With the complementary probability, 1 - it, no loss occurs and his wealth remains at W. He can purchase insurance by paying q pounds for 1 pound coverage. Let a 6 [0, DJ denote the amount of insurance coverage) that he purchases. Bob's utility function with respect to consumption is given by u(x) = ln(x). a. Under which condition(s) does Bob purchase full insurance, i.e. a* = W? [20 marks] b. Under which condition(s) does he purchase no insurance at all, i.e. a* = 0? [20 marks] c. Find the optimal coverage a* when W = 200, D-100, TT = 0.2 and g = 0.3. [10 marks]