Consider an individual who has $A to invest. Let her mean variance utility function be given by the linear function: U = M+bV, where M is the mean of the portfolio and V is its variance. Consider a special case with two uncorrelated risky assets, whose means and variances are given by: μ₁ = 10%, 0₁ = 2, μ₂ = 5%, 02 = 1. (i) Find the solution to the individual's portfolio choice problem. (ii) Show the effect of an increase her wealth (A) on her portfolio choice. (iii) What happens to her portfolio choice when o₁ increases? What happens to her portfolio choice when 02 increases?
Consider an individual who has $A to invest. Let her mean variance utility function be given by the linear function: U = M+bV, where M is the mean of the portfolio and V is its variance. Consider a special case with two uncorrelated risky assets, whose means and variances are given by: μ₁ = 10%, 0₁ = 2, μ₂ = 5%, 02 = 1. (i) Find the solution to the individual's portfolio choice problem. (ii) Show the effect of an increase her wealth (A) on her portfolio choice. (iii) What happens to her portfolio choice when o₁ increases? What happens to her portfolio choice when 02 increases?
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Transcribed Image Text:Consider an individual who has $A to invest. Let her mean variance utility function.
be given by the linear function: U = M+bV, where M is the mean of the portfolio
and V is its variance. Consider a special case with two uncorrelated risky assets,
whose means and variances are given by: ₁ = 10%, 01 = 2, 42 = 5%, 02 = 1. (i)
Find the solution to the individual's portfolio choice problem. (ii) Show the effect
of an increase her wealth (A) on her portfolio choice. (iii) What happens to her
portfolio choice when σ₁ increases? What happens to her portfolio choice when 02
increases?
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