Question: Market observers are quite uncertain whether the stock market has bottomed out from the economic meltdown that began in 2008. In an interview on March 8,2009, CNBC interviewed two prominent economists who offered differing views on whether the U.S. economy was getting stronger or weaker. An investor not wanting to miss out on possible investment opportunities considers investing $10,000 in the stock market. He believes that the probability is 0.30 that the market will improve, 0.40 that it will stay the same, and 0.30 that it will deteriorate. Further, if the economy improves, he expects his investment to grow to $15,000, but it can also go down to $8,000 if the economy deteriorates. If the economy stays the same, his investment will stay at $10,000.
a. What is the expected value of his investment?
b. What should the investor do if he is risk neutral? c. Is the decision clear cut if he is risk averse? Explain.