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THE ECONOMICS OF FINANCIAL MARKETS R. E. BAILEY Exercises for Chapter 4 Decision making under uncertainty 1. Consider an investor who makes decisions according to a mean-variance objective. (a) Sketch indifference curves for the investor (with expected wealth on the vertical axis and the standard deviation of wealth on the horizontal axis). (b) What do you consider the main properties which the indifference curves should be as- sumed to have? How would you justify these assumptions? (c) Compare the indifference curves for two investors one of whom is more risk averse than the other. 2. Explain and assess the role of the Expected Utility Hypothesis ( EUH ) in the theory of portfolio selection. 3. What is meant by the “Fundamental Valuation Relationship”? Discuss its role in the theory of portfolio decision making. 4. Consider a world in which there are exactly two assets (labelled A and B ) and two states of nature (labelled 1 and 2). The payoff of the assets in the two states is as follows:
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This note was uploaded on 03/21/2011 for the course ECON 6120 taught by Professor Crabbe during the Spring '11 term at University of Ottawa.

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