The Parameter R in the Exponential Utility Function U(x) =

question 33

Multiple Choice

The parameter R in the exponential utility function U(x) = 1 - e^-x/R represents the decision maker's risk tolerance. Larger values of R indicate that the decision maker

• A)is less risk averse (closer to neutral).
• B)is more risk averse (has less risk tolerance).
• C)is not concerned with risk.
• D)will accept the gamble.

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Definitions:

Expected Inflation Rate

The anticipated rate at which the general level of prices for goods and services will rise over a period of time.

Risk Averse

The preference to avoid uncertainty, referring to the behavior of investors who prefer lower returns with known risks over higher returns with unknown risks.

Risk-Free Rate

An ideal rate of return on an investment with no risk, typically represented by government bond yields.

Market Risk Premium

The increased return an investor hopes to gain by investing in a risky market portfolio rather than in assets free of risk.