Snarky Behavior

I’m Offering Insurance

October 22, 2008 · 2 Comments

on my fellowship for next semester.  For it to roll-over, I need a B+ GPA for this year.  Since I’m taking 6 classes and TA’ing another, I’ve been really crunched on time, and my GPA isn’t looking so hot right now.  If I were to take a stab at my current post-midterm grades (equally weighted in terms of credits), they would look like this (you can think of “projected grades” as “credit ratings,” with anything above B+ or > 3.33 as “investment grade”):

Urban Economics:  B- (2.67)

Public Economics:  B+ (3.33)

International Capital Markets:  C+ (2.33)

Decision Models:  A (4.00)

Educational Leadership Consulting:  A (4.00)

Cost-Benefit Analysis:  B (3.00)

That’s a GPA of 19.33/6 or 3.22, which is less than the required 3.33.

INSURANCE

So here’s how insurance markets work:  I have two possible outcomes, one in which I get my GPA for the semester above 3.33 (and keep my fellowship, valued at $6000), and another where I do not (costing me $6,000).  I would like to pay a premium such that I can hedge my risk and know with certainty that I will have some approximate value close to $6,000.

My expected value in these two uncertain states of the world depends on the likelihood of failing to get the B+ average.  I’m not TOO far off, and presumably I could spend some more time in the classes I’m doing poorly in to help myself out.  So let’s say I’m at about a 10% chance of failure (I’m keeping it low because I’m  confident in my ability to whine my way into safety if I’m within the margin).  My expected return is therefore:

.1x + (1-.1)y = EV, where x is “no fellowship” and y is “earned fellowship.”

.1*($0) + (.9)*($6,000) = $5,400.

If I’m risk neutral or risk adverse, I should be willing to pay a premium of $600 for actuarial fair insurance to pay me $6,000 in the event I don’t get my GPA up.

MORAL HAZARD

This might seem like a good deal to you if you’re assuming I’m an over-achiever and I can get my grades up if I put my mind to it.  Maybe an easy $600 with a low possibility of risk.  Alternatively, you could set up an office pool to share the risk… 10 people accepting 10% shares each ($60) with the responsibility to fork over $600 in the event I fail.

Maybe you could even traunch my grades!  Lower grades pay a higher rate of return than higher grades… if I failed to meet the overall B+ target, but improved in Capital Markets from a C+ to a B, you could shift the weighted burden to whomever was holding the traunch that held me back, and insulate the riskier traunches.

What about other derivative markets?  Credit default swaps?

Of course the moral hazard is:  if I know with certainty my expected value, I lose the incentive to work harder, and my risk profile shifts dramatically.  Instead of a 10% chance of underperforming, I’m maybe 50-50%.  In the presence of insurance, my behavior shifts dramatically.

So all that in mind, who wants to insure me?

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