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Utility Theory and Arbitrage Pricing Theory Mr Morgan has a utility function U(W) = -W^-1, where W refers to the level of wealth. He is
Utility Theory and Arbitrage Pricing Theory Mr Morgan has a utility function U(W) = -W^-1, where W refers to the level of wealth. He is exposed to a 50/50 chance of gaining or losing 1,000. An insurance that guarantees him the expected payoff costs 500, at what level of wealth will he be indifferent relative to taking the gamble or paying the insurance? Suppose there are two risky assets on the market, Security A and Security B. Security A has a beta of 1.2 and an expected return of 15%. Security B has a beta of 0.8 and an expected return of 10%. The risk-free rate is 3%. Explain how you would take advantage of the arbitrage opportunity. Name four variables that Chen, Roll, and Ross (1986) used to measure the impact of macroeconomic factors on security returns. Briefly explain the reasoning behind their model
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