Consider a market where there are N rational traders. All of these traders have CARA preferences with risk aversion parameter y 1. They are considering a stock that will pay a terminal dividend in the next period. The expected payoff of the dividend is $40 per share with a standard deviation of $5. Assume that the discount rate is zero. That is, don't worry about discounting future payoffs. Also, there are M irrational traders. They each will short two shares of the stock no matter what the price. a) If there are 50 shares of the stock outstanding, what is the price of the stock as a function of N and M? b) If M increases, does the price of the stock rise or fall? Explain the intuition of this result. c) If N increases, does the price of the stock rise or fall? Explain the intuition of this result.

Consider a market where there are N rational traders. All of these traders have CARA preferences with risk aversion parameter y 1. They are considering a stock that will pay a terminal dividend in the next period. The expected payoff of the dividend is $40 per share with a standard deviation of $5. Assume that the discount rate is zero. That is, don't worry about discounting future payoffs. Also, there are M irrational traders. They each will short two shares of the stock no matter what the price. a) If there are 50 shares of the stock outstanding, what is the price of the stock as a function of N and M? b) If M increases, does the price of the stock rise or fall? Explain the intuition of this result. c) If N increases, does the price of the stock rise or fall? Explain the intuition of this result.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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