8. Strengths and weaknesses of New Keynesian Dynamic Stochastic General Equilibrium Models Critically assess the strengths and weaknesses in the structure and interpretations of the basic New Keynesian (NK) Dynamic Stochastic General Equilibrium (DSGE) model. Would you agree with the view that the model relies on an overstylized model of price adjustment? (100 marks) 3. Suppose a fraction a of your wealth is invested in risky asset 1 and the rest in risky asset 2. For asset 1, its expected return is , and the standard deviation is . For asset 2, its expected return is 72, and the standard deviation is 2. The correlation between these two assets is P1,2. Derive the minimum variance frontier (variance and expected return) when these two assets are perfectly negatively correlated. (Total 50 Marks a) The following predictions have been made regarding the economic states, share A and share B. Probability of the state Share A rate of return Share B rate of return State Recession 0.10 -0.20 0.30 Normal Boom 0.50 0.40 0.10 0.20 0.70 0.50 Calculate the expected return and standard deviation for share A Calculate the expected return and standard deviation for share B. b) Assume you observe the following situation: Security Beta Expected Return A 1.2 13% B 0.6 10% The Treasury Bill rate is 5 percent. Which one of the two securities is overvalued relative to the other? Show your working