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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 riskaversion 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 riskaversion utility functions (both abso lute and relative)....
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 Spring '08
 MBIEKOP
 Economics

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