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Suppose that a risk-averse individual has a wealth level W_o. This individual has the option of investing in the risk-free asset with a return of
Suppose that a risk-averse individual has a wealth level W_o. This individual has the option of investing in the risk-free asset with a return of (1 + r_j) There Is another asset that is risky with a return of (1 + r/2) in a good state with probability 1/2 and (1 + r_l) in a bad state with probability 1/2 The expected return from the risky asset is: 1/2 (1 + r_l) + 1/2(1 r_h) We assume that the expected return on the risky asset Is higher: 1/2(1 + r_l) + 1/2(1 = r_h) > (1 + r_f) 1/2r_l + 1/2 r_h > r_f Show that a risk-averse person will always invest some amount in the risky asset. What will be the amount invested in the risky asset if 1/2 r_l + 1/2r_h = r_f
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