Question: points The consumer has a utility function given by U(C)=In(C). Her subjective discount factor is given by 0.8. There are two states of the

points The consumer has a utility function given by U(C)=In(C). Her subjective discount factor is given by 0.8. There are two

points The consumer has a utility function given by U(C)=In(C). Her subjective discount factor is given by 0.8. There are two states of the world next period. Given contingent claim prices the individual chooses a level of consumption Co today and 16 in state 1 and 17 in state 2. Using this information (a) Calculate the value of the stochastic discount factor (SDF) in each state in terms of Co (8 marks). (b) How do the prices of contingent claims in the two states change in response to Co and discuss the intuition for this relationship (10 Marks) (c) Suppose that the individual gets a tax rebate in the current period. Explain how she would change her decision if she wishes to maximise utility. (7 marks)

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a To calculate the stochastic discount factor SDF in each state we can use the formula SDF uC1 p1 uC... View full answer

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