PRIFYSGOL ABERYSTWYTH UNIVERSITY
DEGREE EXAMINATIONS – May/June 2009
ARHOLIADAU GRADD – Mai/Mehefin 2009
SEMESTER 2
EC30610 – UNCERTAINTY AND ASYMMETRIC INFORMATION
Time Allowed: ONE AND A HALF hours
Answer TWO questions
1. An individual owns a house worth £350,000, and there is a 5% chance that it will
be totally destroyed by fire (reducing its value down to that of the site: £100,000).
She must decide whether to take out insurance to cover this risk. Assume that only
full insurance is offered and suppose that her preferences can be represented by a
von Neumann-Morgenstern utility function of the following form:
a) Is the individual risk adverse?
b) Explain the concept of a fair insurance premium and identify its value in this
case.
c) Why in practice is the premium likely to be worse than fair?
d) What is the maximum premium that the individual would be prepared to pay?
e) How does the purchase of actuarially fair insurance turn an uncertain situation
into a situation where the expected value of income is received with certainty?
2. Explain the “lemons” problem. What measures can be taken by buyers and sellers
to deal with the problem?
3. Explain what is meant by a signalling game, and critically examine the Spence
education model in this context.
4. How can different kinds of auction lead to revenue-equivalence when applied to the
benchmark model? What differences in revenue occur when the benchmark
assumptions are relaxed?
5. How is the concept of asymmetric information relevant to the operation of financial
markets? Explain the most important protective measures which can be taken to
offset the impact of such asymmetry.
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