Rollo Megabux has $1 million to invest in stocks or bonds. The percentage yield on each investment during the coming year depends on whether the economy has a good or a bad year (see Table).
|
|
Economy Has Good Year |
Economy Has Bad Year |
|
Yield on stocks |
22% |
10% |
|
Yield on bonds |
16% |
14% |
It is equally likely that the economy will have a good or a bad year.
a If Rollo is risk neutral, how should he invest his money?
b For $10,000, Rollo can hire a consulting firm to forecast the state of the economy. The consulting firm’s forecasts have the following properties:
P(good forecast|economy good) = .80
P(good forecast|economy bad) = .20
Should Rollo hire the consulting firm? What are EVSI and EVPI?