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Problem 2 Uncertainty and Asset Pricing John and Benjamin are investors who trade shares of two companies: Rainalot Inc. (x1) and HateRain Inc. (2). There
Problem 2 Uncertainty and Asset Pricing John and Benjamin are investors who trade shares of two companies: Rainalot Inc. (x1) and HateRain Inc. (2). There are two equally likely states of the world in the future: rain and no rain, and the profits of the two companies are risky. The dividend from one share of Rainalot Inc is $1 when it rains and $0 otherwise, and dividends of HateRain Inc. are $0 when it rains and $1 otherwise. John initially has 100 shares of Rainalot Inc and no shares of HateRain Inc. (w= (100, 0)), and the endowment of Benjamin is w = (0, 100). Both investors maximize the expected utility given by U'(21, 262) = (1/2) In(x1) + (1/2) In(x2) for i = J, B Problem 3 IN a) Plot an Edgeworth box and mark the allocation corresponding to the initial endowments. Argue that such an allocation is (or is not) Pareto efficient. Are the endowments risky? b) Find the equilibrium prices of the two companies shares and allocations. Show them on the graph. c) Is the equilibrium allocation efficient? Is it risky
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