Exam 11: Risk and Information in Contracts

Suppose a fashion designer wins a bid to design clothes for the characters of a movie.During his work he finds out that the payment he receives would not only cover his production costs but also earn him profits.The producer of the movie can be said to be facing a winner's curse.

In a principal/agent relationship, _____ can help to reduce the damage caused by a winner's curse, provided both the parties are well-informed.

According to the theory of propitious selection:

_____ is the price paid by the insured to sell the risk to the insurer, which must cover the expected payout if a disaster occurs.

When is disclosure economically desirable?

Assume that the utility function of an individual is represented as U =√W - 0.001W; where W (his present wealth) = $250,000.He considers investing in a gamble which would double his wealth if he wins but still leave him with $250,000 if he loses.Given that his probability of winning is 0.6, calculate his expected wealth from the bet.

Even if an insurance company holds a substantial reserve to pay claims, the algebra of probability shows that its funds are likely to be exhausted in payouts.