Consider a simple two-period economy with two possible states of the world in the second period. Two financial assets are traded and the matrix is given by (columns refer to assets, rows to states of nature): returns 1 6. 4 (a) If the prices of assets 1 and 2 are given by 1 and 5, respectively, what are the risk-neutral probabilities in this economy? (b) Could prices 3 and 18 be the equilibrium prices for asset 1 and 2, tively? respec- (c) If the price of asset 1 is 3 and the risk-neutral probabilities are 2/3 and 1/3 for state 1 and 2, respectively, what is the no-arbitrage equilibrium price of the second asset?

Consider a simple two-period economy with two possible states of the world in the second period. Two financial assets are traded and the matrix is given by (columns refer to assets, rows to states of nature): returns 1 6. 4 (a) If the prices of assets 1 and 2 are given by 1 and 5, respectively, what are the risk-neutral probabilities in this economy? (b) Could prices 3 and 18 be the equilibrium prices for asset 1 and 2, tively? respec- (c) If the price of asset 1 is 3 and the risk-neutral probabilities are 2/3 and 1/3 for state 1 and 2, respectively, what is the no-arbitrage equilibrium price of the second asset?

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Question

Consider a simple two-period economy with two possible states of the world in
the second period. Two financial assets are traded and the matrix of returns
is given by (columns refer to assets, rows to states of nature):
[: ]
1
6.
1
4
(a) If the prices of assets 1 and 2 are given by 1 and 5, respectively, what are
the risk-neutral probabilities in this economy?
(b) Could prices 3 and 18 be the equilibrium prices for asset 1 and 2, respec-
tively?
(c) If the price of asset 1 is 3 and the risk-neutral probabilities are 2/3 and
1/3 for state 1 and 2, respectively, what is the no-arbitrage equilibrium
price of the second asset?

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