Lecture 16 - 10/1/2010 Agenda FinancialEconomics Lecture16...

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10/1/2010 1 Financial Economics Lecture 16 Economics 3330 Cornell University October 1, 2010 Agenda LC: Complete Portfolios TC: Insurance NC: Preliminary Exam I Chapters 1 6, 14 16 OH today 2:30 3:30 TA office hours: 1 2:30 Saturday The Complete Portfolio Problem Problem: to maximize utility subject to feasible complete portfolios Utility: U = E(r C )–½ A σ C 2 2 Optimal risky portfolio (r P , σ P ) and risk free asset (r f , 0) are given Capital allocation line: E(R C ) and σ C as a function of y E[R C ] = r f + y E[r P r f ] σ C 2 = y 2 σ P 2 Optimal Complete Portfolio Choose y to maximize utility U = E(r C )–½ A σ C 2 Max r f + y E[r P r f ]–½ A y 2 σ P 2 FOC: E[r P r f ]–A y * σ P 2 = 0 y * =(E [ r P ] r f )/ (A σ P 2 ) Interpretation of FOC?
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Lecture 16 - 10/1/2010 Agenda FinancialEconomics Lecture16...

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