Question: There are two possible states Normal and Disaster, and two tradable assets: a risky portfolio market, and a risk-free bond. Per dollar of investment,

There are two possible states Normal and Disaster, and two tradable assets: a risky portfolio market, and a

There are two possible states Normal and Disaster, and two tradable assets: a risky portfolio market, and a risk-free bond. Per dollar of investment, the market portfolio returns 1+rm and 1+rm in states N and D, respectively, and the risk-free asset pays the same rate 1+rf in either state. Assume MRSDN = (CN/CD) * TD/TN for an individual i with consumption levels of cand cin either states. Solve for the optimal demand for two assets as a function of rm, rm, r and the initial wealth W.

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