Calculate the Sentiment Function (please show step by step how to do it, thank you).

These are the steps the professor wants us to follow:

1. Use the asset pricing equation to estimate Arrow-Debreu asset prices. The asset pricing equation for the case of RDU is v_k = w_k/g_k, where w_k are the RDU wights. For the case of Bayes the asset pricing equation is v_k = P_k/g_k, where P_k are the probabilities calculated according to Bayes. Remember that g_k = 1.2 under the strong regime and g_k = 0.95 in the weak regime

2. Calculate relative prices under RDU and Bayes

3. Calculate the log-difference of relative prices

4. Plot the value of the signal (0, 1, 2, 3, 4, 5, 6) agaisnt the log-difference of relative prices. This gives the sentiment function below.

 

Transcribed Image Text:

Number of Ups 0 1 2 3 4 5 6 Number of Ups 0 1 2 3 4 5 6 RDU Strong Regime (Weight of each state) (Weight of each state) 0.049% 0.060% 1.240% 6.320% 16.970% 6.780% 1.930% Weak Regime Strong Regime (Price per state) 0.540% 4.250% 13.130% 30.830% 13.130% 4.250% 0.540% Weak Regime (Price per state) Number of Ups 0 1 2 3 4 5 6 Number of Ups 0 1 2 3 4 5 6 Bayes Strong Regime (Probability of each state) 0.050% 0.550% 2.740% 7.320% 10.970% 8.780% 2.930% Strong Regime (Price per state) Weak Regime (Probability of each state) 1.040% 6.250% 15.630% 20.830% 15.630% 6.250% 1.040% Weak Regime (Price per state) Number of Ups 0 1 2 3 4 5 6 RDU Relative Prices Bayes Log-difference Relative Prices Number of Ups 0 1 2 3 4 5 6 Number of Ups 0 1 2 3 4 5 6 RDU Strong Regime (Weight of each state) (Weight of each state) 0.049% 0.060% 1.240% 6.320% 16.970% 6.780% 1.930% Weak Regime Strong Regime (Price per state) 0.540% 4.250% 13.130% 30.830% 13.130% 4.250% 0.540% Weak Regime (Price per state) Number of Ups 0 1 2 3 4 5 6 Number of Ups 0 1 2 3 4 5 6 Bayes Strong Regime (Probability of each state) 0.050% 0.550% 2.740% 7.320% 10.970% 8.780% 2.930% Strong Regime (Price per state) Weak Regime (Probability of each state) 1.040% 6.250% 15.630% 20.830% 15.630% 6.250% 1.040% Weak Regime (Price per state) Number of Ups 0 1 2 3 4 5 6 RDU Relative Prices Bayes Log-difference Relative Prices

Answer rating: 100% (QA)

To calculate the sentiment function following the given steps well start by calculating the ArrowDebreu asset prices for both RDU and Bayes then find the relative prices and then the logdifference of ... View the full answer