Answered step by step
Verified Expert Solution
Question
1 Approved Answer
Consider an economy with 3 states. Two assets are traded in this economy: A = (100, 100, 100) and B = (105, 100, 95).
Consider an economy with 3 states. Two assets are traded in this economy: A = (100, 100, 100) and B = (105, 100, 95). a. (6 points) Explain why the market is not complete. Explain with supporting calculations. b. (10 points) Can the market be completed by allowing for trading a forward contract on B with a forward price of 100? If not, what value of the forward price in the forward contract can complete the market? Explain carefully with supporting calculations. (Hint: assume a forward price of K in the forward contract). c. (6 points) Explain how the market can be completed by trading a call option on B with a strike price of 100 with supporting calculations.
Step by Step Solution
★★★★★
3.42 Rating (177 Votes )
There are 3 Steps involved in it
Step: 1
a The market is not complete because there is no way to replicate asset A using asset B or vice versa To show this we can try to find weights w1 w2 w3 such that w1B1 w2B2 w3B3 A where B1 B2 B3 are the ...Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started