Derive the equilibrium price ratio of the contingent claims

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Reference no: EM131306915

Question - Suppose we have an economy with 1 commodity, two possible states, and two consumers, and no trades at Date 0. Agent 1 is risk-neutral (i.e., Agent 1's utility function satisfies: u"(x) = 0) while Agent 2 is risk-averse (u''(x) < 0).

Assume:

a) Derive the equilibrium price ratio of the contingent claims contract for this economy.

b) Is there a value for the probability π, such that can Agent 2 achieve complete insurance in equilibrium? If so, describe how it will be achieved. What is the value of π, in this instance? (Hint: Try π = .25).

c) What assumption did we make in this problem that was key to the result you obtained in a) and b)? Explain.

Reference no: EM131306915

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