Apply the definition of risk provided in the textbook to an individual's decision to purchase a car insurance policy. Suppose that the individual has two possibilities: no accident ($0 gain/loss) and accident (-$30,000 loss). If the probability of an accident is lower than the probability of an accident occurring (say the probability of an accident is 10%), then why do people buy car insurance? How is this related to the concept of value at risk and the time horizon of investment decisions?
What will be an ideal response?
People buy car insurance in order to share risk with other policy holders. Even the risk- neutral investor would purchase car insurance because the expected return from driving one's car on a regular basis is involves a loss and never a financial gain. Risk-averse investors are willing to pay even more because of the uncertainty in outcomes and the possibility of a large loss. Value at risk refers to the worst possible outcome. This is often something drivers consider because if they drive often, and plan to drive over long periods of time, the probability of observing the worst-case scenario is higher over one's lifetime (compared with a situation where an individual drives for one day only).
You might also like to view...
If an economy produced 220 pounds of jelly beans at $5 per pound and 90 pounds of gum drops at $2 per pound in 2016, its real gross domestic product (GDP) was
A) 310 pounds of candy. B) $180. C) $1,100. D) $1,280.
The proportion of minimum-wage earners who are in families with incomes below the poverty line is
a. less than one-third. b. between one-third and one-half. c. between one-half and two-thirds. d. greater than two-thirds.
When the demand curve is linear, price elasticity of demand:
a. remains constant along the curve. b. is negative in the lower half of the curve. c. decreases as one moves down along the curve. d. is less than one in the upper half of the demand curve.
The Federal Reserve System is the
A) federal government agency that collects taxes and spends these receipts on tanks, bridges, government employees' salaries, etc. B) company that delivers packages to your front door. C) central bank of the United States. D) federal government agency that collects and disseminates all the economic data that economists are interested in.