Consider an economy with 3 states. Two assets are traded in this economy: A = (100,...

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Consider an economy with 3 states. Two assets are traded in this economy: A = (100, 100, 100) and B = (105, 100, 95). a. (6 points) Explain why the market is not complete. Explain with supporting calculations. b. (10 points) Can the market be completed by allowing for trading a forward contract on B with a forward price of 100? If not, what value of the forward price in the forward contract can complete the market? Explain carefully with supporting calculations. (Hint: assume a forward price of K in the forward contract). c. (6 points) Explain how the market can be completed by trading a call option on B with a strike price of 100 with supporting calculations. Consider an economy with 3 states. Two assets are traded in this economy: A = (100, 100, 100) and B = (105, 100, 95). a. (6 points) Explain why the market is not complete. Explain with supporting calculations. b. (10 points) Can the market be completed by allowing for trading a forward contract on B with a forward price of 100? If not, what value of the forward price in the forward contract can complete the market? Explain carefully with supporting calculations. (Hint: assume a forward price of K in the forward contract). c. (6 points) Explain how the market can be completed by trading a call option on B with a strike price of 100 with supporting calculations.

Answer rating: 100% (QA)

a The market is not complete because there is no way to replicate asset A using asset B or vice versa To show this we can try to find weights w1 w2 w3 such that w1B1 w2B2 w3B3 A where B1 B2 B3 are the ... View the full answer