Question

$($a$)$ In the next period there are three possible states of the world: recession $($with probability $0\mathrm{.}3),$

normal growth $($with probability $0\mathrm{.}4),$ and expansion $($with probability $0\mathrm{.}3).$ There are two

stocks $($stock A and stock $B)$ in the economy. The stocks will yield payoffs next period

according to the following table:

i$)$ Can you rank the stocks by the criterion of first order stochastic dominance? If you can

rank them, which stock first order stochastically dominates the other? You may use a

graph to answer this question if you choose to$.$

ii$)$ Can you rank the stocks by the criterion of second order stochastic dominance? If you can

rank them, which stock second order stochastically dominates the other? You may use a

graph to answer this question if you choose to$.$

iii$)$ Give an explanation of second order stochastic dominance in words $($i$.$e$.$ not using any

equations$).$