Week 2 - Choice under uncertainty Flashcards Preview

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Flashcards in Week 2 - Choice under uncertainty Deck (5)
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1
Q

Diagram examples

A

See notes

2
Q

Describe what actuarily fair insurance is

A
  • If an insurance contract is actuarily fair, the premium you pay for actuarily fair insurance reflects the true probability of the event occurring.
  • This means that purchasing insurance leaves the expected value of the lottery or outcome the same for whether or not you have purchased insurance.
3
Q

Describe what actuarily unfair insurance is

A
  • The premium you pay for the actuarily unfair insurance does not reflect the probability of the even where you would claim insurance happening.
  • This means that purchasing insurance that is actuarily unfair will mean your expected wealth is less than if you hadn’t purchased the insurance.
4
Q

How can you calculate whether insurance is actuarily fair or not?

A
  • Divide the premium of the insurance by the amount of insurance it covers and if this is equal to the probability then its actuarily fair.
  • For example say a £1 premium covers £5 worth of insurance, and the probability of claiming insurance is 0.2. Then this would be actuarily fair as 1/5=0.2
5
Q

Worked example

A

See Notes