Two investors, A and B, trade the stock TWTR. Each investor maximizes his expected future wealth...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
Two investors, A and B, trade the stock TWTR. Each investor maximizes his expected future wealth subject to a penalty for risk (as discussed in Chapter 5). Investor A's optimal position measured i amounts of money x4 is given by xA= (yA)-¹0-¹E(R²) Recall that yA is the risk aversion, is the risk of TWTR (i.e., variance), and E(R) is the expected excess return. The absolute risk aversion is decreasing in the investor's wealth WA such that yA = 1/WA. Further, the current dividend yield and risk free rate are zero so investor A's expected excess HA_P return is given by E (R²) = where ª > 0 is his expectation of the value of a share next year. P r (μ^-P) = ² · Finally, = var The same expressions hold for investor B with two exceptions. First, his wealth is WB and, second, his expectation is that the stock will be worthless next year (μ³ = 0) so that his expected return is E(Re) = -1 and his position is x = WB(-1). The supply of shares is given by s. a. Explain why equilibrium is characterized by the condition that XA XB P P+= =S and show that the equilibrium price without short-sale constraints is (where we assume throughout that the numerator is positive): WAμA-so WA+WB b. Is investor A long or short? What about investor B? P c. What is the equilibrium price if no investor is allowed to sell short? How does the answer compare to the equilibrium without short-sale constraints in question a.? Two investors, A and B, trade the stock TWTR. Each investor maximizes his expected future wealth subject to a penalty for risk (as discussed in Chapter 5). Investor A's optimal position measured i amounts of money x4 is given by xA= (yA)-¹0-¹E(R²) Recall that yA is the risk aversion, is the risk of TWTR (i.e., variance), and E(R) is the expected excess return. The absolute risk aversion is decreasing in the investor's wealth WA such that yA = 1/WA. Further, the current dividend yield and risk free rate are zero so investor A's expected excess HA_P return is given by E (R²) = where ª > 0 is his expectation of the value of a share next year. P r (μ^-P) = ² · Finally, = var The same expressions hold for investor B with two exceptions. First, his wealth is WB and, second, his expectation is that the stock will be worthless next year (μ³ = 0) so that his expected return is E(Re) = -1 and his position is x = WB(-1). The supply of shares is given by s. a. Explain why equilibrium is characterized by the condition that XA XB P P+= =S and show that the equilibrium price without short-sale constraints is (where we assume throughout that the numerator is positive): WAμA-so WA+WB b. Is investor A long or short? What about investor B? P c. What is the equilibrium price if no investor is allowed to sell short? How does the answer compare to the equilibrium without short-sale constraints in question a.?
Expert Answer:
Answer rating: 100% (QA)
Equilibrium in the Stock Market with RiskAverse Investors a Equilibrium Condition and Price Derivati... View the full answer
Related Book For
Advanced Financial Accounting
ISBN: 978-0078025624
10th edition
Authors: Theodore E. Christensen, David M. Cottrell, Richard E. Baker
Posted Date:
Students also viewed these finance questions
-
1. How strong are the competitive forces confronting J. Crew in the market for specialty retail? Do a [Michael Porter] five-forces analysis to support your answer. (see chapter 3 in the textfor...
-
Managing Scope Changes Case Study Scope changes on a project can occur regardless of how well the project is planned or executed. Scope changes can be the result of something that was omitted during...
-
The Crazy Eddie fraud may appear smaller and gentler than the massive billion-dollar frauds exposed in recent times, such as Bernie Madoffs Ponzi scheme, frauds in the subprime mortgage market, the...
-
Summarize the extract given below? When Paul Farmer graduated from Duke University at 22, he was unsure whether he wanted to be an anthropologist or a doctor. So he went to Haiti. As a student, Paul...
-
As a first approximation to the analysis of a space flight from the earth to Mars, it is assumed that the orbits of the earth and Mars are circular and coplanar. The mean distances from the sun to...
-
Rice Automotive ended December 2009 with Accounts Receivable of $30,000 and Allowance for Uncollectible Accounts of $1,500. During January 2010, Rice Automotive completed the following transactions:...
-
Presented below are common-sized income statement data for three well-known companies representing three different industries (pharmaceutical, beverage, and diversified): 1. Bristol-Myers Squibb 2....
-
For the network shown in Figure with all times indicating weeks, answer the following questions: a. What is the impact on the end date of the project if activity F slips by seven weeks? b. What is...
-
GreenTech is considering investing in a new renewable energy project. The project involves setting up a wind turbine farm, which requires an initial investment of $ 1 1 5 million. Financial analysts...
-
WRITE IN PYTHON AND IN THE GIVEN CODE coderbyte medium Back-end Challenge In the Python file, write a program to perform a GET request on the route Time left: Unlimited time...
-
On January 8, the end of the first weekly pay period of the year, Regis Company's employees earned $22,760 of office salaries and $65,840 of sales salaries. Withholdings from the employees' salaries...
-
6. Briones Corp.'s outstanding shares at Dec. 31, 2022, consisted of the following: 30,000 shares of 5% Cumulative Preference Shares, P10 par value, fully participating as to dividends. No dividends...
-
The American RevolutionAmerican Yawp. http://www.americanyawp.com/text/05-the-american-revolution/ Men and women of all ranks contributed to the colonies' most improbable victory in the American...
-
Feldpausch Corporation has provided the following data from its activity- based costing system: Activity Cost Pool Total Cost Total Activity Assembly $1,137,360 84,000 machine-hours Processing orders...
-
Labour data for making one unit of finished product in Bridgeport Company are as follows: (1) Price-hourly wage rate $10.00, payroll taxes $0.80, and fringe benefits $1.30. (2) Quantity-actual...
-
Which defensive tactic is used when an individual is attempting to manipulate and control others?
-
Recall that Chapter 8 described the binary search algorithm for finding a particular entry in an ordered list. The idea behind binary search is to begin looking in the exact center of the list. If...
-
For many years, Clark Company operated exclusively in the United States but recently expanded its operations to the Pacific Rim countries of New Zealand, Singapore, and Australia. After a modest...
-
What effect will a subsidiary's 15 percent stock dividend have on the elimination entries used in preparing a consolidated balance sheet at the end of the year in which the dividend is distributed?
-
What is indirect ownership? How does one company gain control of another through indirect ownership?
-
Presented below are the beginning-of-year common share price (P t-1 ), the end-of-year common share price (P t ), and the annual dividend (D t ) for two competitorsMinaret Company and Owens Company....
-
In Example 13-1, we assumed we were going to use all available solvent. There are other alternatives. Determine if the following alternatives are capable of producing outlet water of desired acetic...
-
A countercurrent extraction system extracts furfural from water into methyl-isobutyl ketone (MIBK) at \(25^{\circ} \mathrm{C}\). Aqueous feed contains 0.0011 wt. fraction furfural and has a feed rate...
Study smarter with the SolutionInn App