You are a risk-averse investor with a CRRA utility function. You are faced with the decision to invest your total wealth W of £1,000,000 into a riskless asset which generates a return of 5% or into a risky asset which either generates a return of 20% or a loss of −4% with equal probability. Find the optimal investment allocation with a coefficient of relative risk aversion η=2, and comment on your results.
You are a risk-averse investor with a CRRA utility function. You are faced with the decision to invest your total wealth W of £1,000,000 into a riskless asset which generates a return of 5% or into a risky asset which either generates a return of 20% or a loss of −4% with equal probability. Find the optimal investment allocation with a coefficient of relative risk aversion η=2, and comment on your results.
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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You are a risk-averse investor with a CRRA utility function. You are faced with the decision to invest your total wealth W of £1,000,000 into a riskless asset which generates a return of 5% or into a risky asset which either generates a return of 20% or a loss of −4% with equal probability.
Find the optimal investment allocation with a coefficient of relative risk aversion η=2, and comment on your results.
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Step 1
Total wealth= £1000000
Returns from investing in riskless asset= 5%
Risky asset which either generates a return of 20%
Loss from investing in risky asset= -4%
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