Suppose, After Undergoing Genetic Testing, You Discover That You Have

question 23

Essay

Suppose, after undergoing genetic testing, you discover that you have a health condition that could result in the emergence of a disability which would make it impossible for you to continue to work.The probability of this happening is 50%.Currently your expected lifetime earnings are $5,000,000, but if the disability hits, your expected lifetime earnings will consist primarily of income earned from government support programs -- and will not add up to more than $1 million.
a.Suppose that you are risk averse and your tastes are state-independent.Illustrate your expected utility in a graph with lifetime consumption on the horizontal and utility on the vertical axis.
b.Illustrate how much you would be willing to pay for full insurance.
c.Illustrate what you showed in (b) in a different graph that has consumption in the "good" state on the horizontal and consumption in the "bad" state on the vertical.
d.What would a full menu of actuarily fair insurance contracts look like in your graph from part (c)? Where would you optimize in that graph?
e.Now suppose that you believe consumption will be more meaningful if the health condition does not materialize.What changes in your graph from part (d)?

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Definitions:

Cash Dividends

Profits distributed by a corporation to its shareholders in the form of cash.

Cash Equivalent

Short-term, highly liquid investments easily convertible to known amounts of cash and so near their maturity that they present minimal risk of changes in value.

Liquid

Describes an asset's ability to be quickly converted into cash without significant loss in value.

Maturity Date

The maturity date is the specified date on a financial instrument at which the principal (or final payment) is due to be paid to the holder.