Foundations of Finance - Essay Example

The explanation states that the utility function formed for wealth is concave in shape. A person who is wealthy has lower marginal utility for any additional wealth. In contrast to it the person who is poor has higher marginal utility for additional wealth. The economist who model risk aversion based on expected utility theory, do so as they arise solely because utility function over wealth is concave. The diminishing value of marginal utility of wealth theory of risk aversion appeals to psychological intuition and helps in explaining some of the large scale risk aversion of humans.

The theory also implies that people become risk neutral when stakes are not high. Differentiable utility function is used by expected utility maximize wants to take a small stake in a positive expected value bet. The approx risk neutrality predictions holds not just for smaller and negligible stakes but also for stakes that are of sizeable size and economically important. While it is not often and universally appreciated by researchers but the expected utility theory fails to provide a plausible account of risk aversion over modest cases and is considered among some small fractions of researchers in different contexts using different types of utility functions.

Let the cable connecting the top of 6 feet tower to junction box be y and the length of the cable connecting the top of 15 feet tower to junction box be z. Let the distance of junction box from the base of 6 feet tower be given by x and the distance of junction box therefore from the 15 feet tower will be given by 20-x. Least cabling is required for the first case if the box is kept at the base of 20 feet tower. Least cost will be required in this case as the cost of the cable that connects 15 feet tower to the junction box is higher than that cable which connects that top of 6 feet tower to the junction box.

Efficient frontier is curved chart patter that defines a set of optimal