1. Uncertainty and Consumer Behavior …Riiiisk….

2. Uncertainty and Risk Risk is associated to uncertain events. Uncertainty refers to unknown outcomes of stochastic variables i.e. dices’ throw. Two cases: Dices: known distribution Unknown distributions: … what the future brings?

3. A Game 1, 2, 3, 4  s (shine) 5, 6  r (rain) Three dices  three days Options sss ssr srr rrr Probabilities P(s) = 2/3 P(r) = 1/3

4. A Game You are given 10 units of money You have to gamble 2 units each time (5 times) Your betting options: If the outcome doesn’t fit with your bet, you give back the money At least 1sAt least 2sAt least 2r3r -75%-50%-25%-0%

5. Distribution Probability At least 1s: P(3s) + P(2s) + P(1s) At least 2s: P(3s) + P(2s) At least 2r: P(2r) + P(3r) 3r: P(3r)

6. Example Your choice  At least 1s At least 2s At least 2r 3rActual Outcome First Round Second Round Third Round Fourth Round Fifth Round Payoff Final Payoff 3,50 -2 -0,25 -2 -6,50

7. Theory of Probability P(3s) =? P(s) = 2/3 P(3s) = P(s) P(s) P(s) P(2s and r)=? P(s) = 2/3 P(r) = 1/3 ssr srs rss  P(2s and r) = 3P(s)P(s)P(r) P(s and 2r)=? P(s and 2r) = 3P(s)P(r)P(r) P(3r) =? P(3r) = P(r)P(r)P(r) P(3s) =2/3*2/3*2/3 = 8/27 P(3s) = 8/27= 0,296 P(2s and r)= 3* 2/3*2/3*1/3 = 12/27 P(2s and r) = 12/27 = 0,444 P(s and 2r)= 3*2/3*1/3*1/3 = 6/27 P(s and 2r) = 6/27 = 0,222 P(3r) = 1/3*1/3*1/3 = 1/27 P(3r) = 1/27 = 0,037

8. The Expected Value of the Distribution = 0*p(3s) + 1*p(2s and r) + 2*p(s and 2r) + 3*p(3r) = 0*0,296 + 1*0,444 + 2*0,222 + 3*0,037 = 1,00 = n*p(r) = 3*1/3

9. The Variance of the Distribution  2 = (0 -1) 2 P(3s)+ (1-1) 2 P(2s and r)+ (2 -1) 2 P(s and 2r) + (3 -1) 2 P(3r)  2 = 1*0,29 + 0*0,44 + 1*0,22 + 2 2 *0,037  2 = 0,29 + 0,22 + 4*0,037  2 = 0,658  2 = nP(s)P(r)  2 = 3*2/3*1/3  2  2

10. Preferences toward Risk (Risk Aversion)

11. Preferences toward Risk (Risk Loving)

12. Risk Aversion and Indifference Curves I  I  U0U0 U1U1 U2U2 U0U0 U1U1 U2U2

13. Measures for Risk Attitudes Absolute Risk Aversion

14. Measures for Risk Attitudes Relative Risk Aversion

15. Risk Coping Strategies Diversification Don’t put all your eggs in one basket Insurance Information