April 2021 Q5 Paper A v)

[sophieactrainee]

Another question related to April 2021 paper.

In part v), it discusses the appropriateness of the quadratic function.

I don't understand in the ASET solution how ' doing nothing yields a sure utility of 64.8181 whereas investing gives an expected utility of only 50' then suggests that 'the reason for this could be that the investor is risk-seeking rather than risk-averse when it comes to trading vegetable boxes' ?

Surely if you get more utility from certainty over risk, then you are not risk-seeking?

Please could someone clear this up, thanks - I must be missing something obvious here...

 

[John Potter]

Yes, I think you're right but that this is the point the solution is making...

We're asked whether the U(w) is appropriate and we're saying that it isn't

For example, the investor’s decision to purchase the seven boxes contradicts the conclusion reached according to U(w). Specifically, doing nothing yields a sure utility of 64.8181 whereas investing gives an expected utility of only 50.

Or, using your words, if you get more utility from certainty over risk, then you are not risk-seeking - absolutely. So, the fact that the investor has purchased 7 veg boxes against the "will" of his/her own utility function, shows us that this U(w) can't possibly be right for this investor. It looks from the veg box trading that this investor may even be risk averse!

Good luck!
John