3. Consider a stochastic DGE model with uncertainty about future income and interest rates. The representative consumer has the utility function U₁=EB'u(c), faces the budget constraint c, +a, = y₁+(1+r),,, for 1-0 120, and has an initial assets position given by a.. a) Derive analytically the Euler equation for the optimal allocation of consumption. b) Use your result to explain why the covariance between consumption and assets' return is a measure of macroeconomic risk and how this affects consumption. c) Show how your result can be used to derive a formula for pricing risky assets and provide an economic interpretation.

3. Consider a stochastic DGE model with uncertainty about future income and interest rates. The representative consumer has the utility function U₁=EB'u(c), faces the budget constraint c, +a, = y₁+(1+r),,, for 1-0 120, and has an initial assets position given by a.. a) Derive analytically the Euler equation for the optimal allocation of consumption. b) Use your result to explain why the covariance between consumption and assets' return is a measure of macroeconomic risk and how this affects consumption. c) Show how your result can be used to derive a formula for pricing risky assets and provide an economic interpretation.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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