Question
Assume that households are risk neutral in period 2 rather than risk-averse. ln(C 1 ) + E(C 2 ) where C 1 and C 2
Assume that households are risk neutral in period 2 rather than risk-averse.
ln(C1) + E(C2) where C1 and C2 are the consumption in periods 1 and 2, respectively. Note that the second period utility does not have any logarithmthe preferences are logarithmic in period-1 but linear in period-2 consumption. Assumed that the households can borrow or lend at the foreign interest rate r*. Furthermore, consider a situation in which Q1=Q, but Q2 is unknown in period 1.
Q2 = { Q + with p=0.5 and Q with (1p) = 0.5
Finally, assume B*0=0.
1a. Compute the expected value and the standard deviation of Q2 (the endowment in period 2).
b. Assume that =0. Find the equilibrium values of C1 and B*1.
c. Now assume that >0. Find the equilibrium value of B1. What is the predicted effect of the precautionary savings on the current account? Explain.
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