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4721_HW3

# 4721_HW3 - Econ 4721 Money and Banking Fall 2008 Homework 3...

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Econ 4721: Money and Banking, Fall 2008 Homework 3 Due riday, November 21, at the beginning of class. 1 Problem 1. Risky Lending Consider a standard two-period OLG economy, where population grows according to the process N t = 1 . 08 N t - 1 and the stock of ﬁat money is constant. Suppose that agents in this economy are able to hold ﬁat money (a perfectly safe asset), or may lend to some other agents who have a 10% chance to default on their debt. In case of no default, the borrower repays the loan back and oﬀers a gross real return of r per unit of consumption. (a) Calculate the rate of return r * in the stationary equilibrium, assuming that agents are risk-neutral. (b) Now assume that everybody in this economy became risk-averse. Explain what you expect to happen to the equilibrium value of r * . 2 Problem 2. Risky Assets Consider an individual consumer who lives for two periods, endowed with y = 40 goods when young and nothing when old. The consumer wants to save half of the endowment (thus, 20 goods). Saving can be done in either a safe (risk-free) asset (asset a ) or a risky asset (asset b ). The real rate of return on asset

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4721_HW3 - Econ 4721 Money and Banking Fall 2008 Homework 3...

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