ENNN

07/03/2023
DEPARTMENT OF STATISTICS AND ACTUARIAL SCIENCE
UNIVERSITY OF GHANA
STAT 461: BAYESIAN STATISTICS
EXERCISE 2
(Submission date: On or before 17/03/2023 @ 17:00 GMT)
1. Compare the expected value of the new business to the expected utility that the venture
capitalist derives from it. How would you describe the investor’s attitude to risk?
An investor (Nellis) with wealth (w) of GHc1000 is given an opportunity to take one of
two prospects. The first prospect (A) offers a 25% chance of winning GHc 200 and a 75%
chance of winning GHc 900. The second prospect (B) offers a 40% chance of winning
GHc 600 and a 60% chance of winning GHc 800.

(a) Nellis’ utility function is that of the natural log function [so U ( w) = ln( w) ].
Sketch Nellis' utility function and describe Nellis' attitude to risk and show how
Nellis would evaluate the two prospects (A and B) above and choose between them.

(b) Assuming that Nellis chose prospect (A), at what cash value would he be
indifferent to taking the prospect or having the cash [i.e. what is the certainty
equivalent of prospect (A)]?

(c) A second investor (Akua) has wealth of GHc 750 but she has a utility function
described as U ( w) = w .

(d) Explain whether Nellis or Akua has a higher level of risk aversion. [Justify
your answer and show your working clearly.]
2. Differentiate the following terms/concepts:

(a) Prospect and probability distribution;

(b) Risk and uncertainty;

(c) Utility function and expected utility;

(d) Risk aversion, risk seeking, and risk neutrality.

3. Consider a person with the following utility function over wealth: U ( w) = exp( w) , where
exp is the exponential function (and w = wealth in hundreds of thousands of Ghana Cedis.
Suppose that this person has a 40% chance of wealth of GHc 50,000 and a 60% chance of
wealth of GHc 1,000,000 as summarized by P(0.4, GHc 50, 000 , GHc1, 000, 000) .

(a) What is the expected value of wealth (in both GHc and utility)?

(b) Construct a sketch graph of this utility function.

(c) Is this person risk averse, risk neutral, or a risk seeker?

(d) What is this person’s certainty equivalent for the prospect?

4. Let X = ( X1 , X 2 , , X n ) be a random sample taken from the probability distribution

f ( x  ) . Find the posterior distribution for the given sample with density f ( x  ) and prior

distribution given:

(i) f ( x  ) =  exp(− x) ,  ( ) = 2exp(−2 )

 x e −  4 e −3
(ii) f (x  ) = ,  ( ) = 5
x! 1
24  
3
5. (a) Given that X = ( X1 , X 2 , , X n ) represents a random sample of size n from a

Normal distribution with unknown mean  and unknown variance  2 denoted by

N (  ,  2 ) and the prior distribution of  is N ( 0 ,  02 ) , show that the posterior

distribution of  is N ( 1 ,  12 ) where

nX /  2 + 0 /  02 1
1 = and  12 = .
n /  2 + 1/  02 n /  + 1/  02
2

(b) Suppose the prior distribution of  is N (12, 4) . A single observation x is taken.

Find the posterior distribution for  in this case. In the case where  2 = 6 and
x = 10 , find the posterior probability that   15 .

6. (a) Determine the Bayes estimate of the Bernoulli parameter p based on a sequence
of n independent trials, assuming a prior density proportional to p(1 − p) , 0  p  1
and a quadratic loss.

(b) In a sequence of 10 such Bernoulli trials, 1 success was observed. Using the above
prior density, find the Bayes estimator of the proportion p ,

(i) using a quadratic loss function;

(ii) using absolute-error loss function;

(iii) Compare the estimates found in (ii) and the maximum likelihood estimator
of p and comment on any differences found.
7. The number of misprints spotted on the first few pages of an early draft of a book follow a
Poisson distribution with unknown mean  .

(i) Assuming the prior distribution for  is:

 ( ) is proportional to  −1/2

Find the posterior distribution for  .

(ii) If the number of misprints spotted on the first six pages of the early draft of a book
were: 3 , 4 , 2 , 1 , 2 , 3.

Find a 95% equal-tailed credible interval for  .