Question
Ali and Ben are both starting with a unit initial wealth: W=1. They are looking to invest their entire wealth in an investment with two
Ali and Ben are both starting with a unit initial wealth: W=1. They are looking to invest their entire wealth in an investment with two possible outcomes: a return of 54.5%, with probability 0.5, or a return of -54.5%. Ali evaluates the investment using a constant relative risk aversion utility function U(x)=x. Ben's utility is given by U(x)=ln(x).
(a) For Ali, compute her coefficient of relative risk aversion, evaluated at her initial wealth.
(b) For Ben, compute his coefficient of relative risk aversion, evaluated at his initial wealth.
(c) What risk premium does Ali attach to the above return distribution? Compute the exact value, report two decimal places.
(d) What risk premium does Ben attach to the above return distribution? Compute the exact value, report two decimal places.
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