Problem Set 2 Solutions(2)

Levkoff c note that above we found that using

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Unformatted text preview: ) Note that above we found that . Using variables indexed by , we have Using summation notation with (∑ ∑ ∑ ∑∑ 2. ) terms, we write: ∑ ∑ ∑ ( ∑ ( ) ( ) ) Economics 171 Problem Set 2 Solutions S. Levkoff Economics 171 Problem Set 2 Solutions S. Levkoff 3. a) Let us begin with Asset A. The expected return is given by: The variance is given by: Now we can compute the expected return and variance for Asset B. The variance is given by: The covariance between Assets A and B is given by: [ [ Note that So [ We could alternatively write: [ [ [ ]] Plugging in, we have: b) We first need to determine the optimal portfolio of Assets A and B. To do this, we minimize riskiness: We obtain the following first-order condition: Economics 171 Problem Set 2 Solutions S. Levkoff So, So if there is $500 to spend on Assets A and B, then Asset A and should be allocated to Asset B. should be spent on...
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