You possess Prospect Theory preferences. You and your colleague have been competing against each other to...

 

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You possess Prospect Theory preferences. You and your colleague have been competing against each other to see who has better stock picking abilities. Both of you began with investing $5,000 in stocks in January 2017. It is now April 2017. The value of your portfolios at the end of the month over the past three months is as follows Your Portfolio $5,000 $10,000 $9.000 January February March Colleague's Portfolio $5,000 $15,000 $6,000 a) Assume that you take your colleague's portfolio value to be your reference point. Write down each month and the gain relative to the reference point for that month. (I am looking for three numbers. Indicate losses with a negative number). (1 mark) b) Explain whether you would behave like a risk-averse or risk-loving investor in February (1 mark) and March (1 mark). c) Give an example of how a risk-averse investor would trade. (1 mark) Consider the following GARCH(1,1) model for variance: o = 0.001 +0.750²-₁ +0.02r² 1 a) Why do finance professional model volatilities as being time-varying? (1 mark) b) The coefficient on o₁ is much greater than the coefficient on r². What does this tell us about how volatility 1 changes over time? (1 mark) c) What is the long-term (or unconditional) variance associated with this model? (1 mark) You possess Prospect Theory preferences. You and your colleague have been competing against each other to see who has better stock picking abilities. Both of you began with investing $5,000 in stocks in January 2017. It is now April 2017. The value of your portfolios at the end of the month over the past three months is as follows Your Portfolio $5,000 $10,000 $9.000 January February March Colleague's Portfolio $5,000 $15,000 $6,000 a) Assume that you take your colleague's portfolio value to be your reference point. Write down each month and the gain relative to the reference point for that month. (I am looking for three numbers. Indicate losses with a negative number). (1 mark) b) Explain whether you would behave like a risk-averse or risk-loving investor in February (1 mark) and March (1 mark). c) Give an example of how a risk-averse investor would trade. (1 mark) Consider the following GARCH(1,1) model for variance: o = 0.001 +0.750²-₁ +0.02r² 1 a) Why do finance professional model volatilities as being time-varying? (1 mark) b) The coefficient on o₁ is much greater than the coefficient on r². What does this tell us about how volatility 1 changes over time? (1 mark) c) What is the long-term (or unconditional) variance associated with this model? (1 mark)

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It seems there are two separate issues addressed in the images you have presented one concerning Prospect Theory preferences and stock portfolio perfo... View the full answer