An investor has preferences represented by the following utility function:

12 u(w)= (ww ) ,

2

where w is a parameter. She can invest her wealth w in a risk-free asset with net return rf and in a risky asset (say a stock) with return r, such that Er > rf . Compute how the demand for the stock changes when a) the investor becomes richer; b) the excess return x Errf increases. Explain your results carefully.