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Unformatted text preview: Econ 333 - Financial Economics Spring 08 Homework #2: Anwer keys Exercise 1: Risk aversion. Consider the following functions (defined over wealth Y): U ( Y ) = Y U ( Y ) = Y- Y 2 . a - Check that they are well behaved ( U > , U 00 < 0) or state restrictions on the param- eters so that they are. For the second function, take positive and , and give the range of wealth over which the utility function is well behaved. Answer : U ( Y ) = Y - 1 > U 00 ( Y ) = ( - 1) Y - 1 < > 1 U ( Y ) = - 2 Y > Y < 2 U 00 ( Y ) =- 2 < b - Compute the absolute and relative risk-aversion coefficients Answer : R A = 1- Y R r = 1- R A = 2 - 2 Y > R r = 2 - 2 Y Y > c - What is the effect of parameter ? Answer : controls for the degree of risk aversion. We check it with the derivative of R A and R r w.r.t. . d - Classify the function as increasing/decreasing risk-aversion utility functions (both abso- lute and relative)....
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- Spring '08