Answer Happy

5. There are two states of nature (s1, $2) with equal probabilities. Suppose there is a representative agent who is endowed with 1 unit of consumption today, and (2, 1) tomorrow. The agent has power utility u(c)(c - 3)², c<3< and B-1. In the asset market, there is a security with payoff (1,0) and a risk-free bond that pays (1,1).< (a) The Capital Asset Pricing Model holds when the representative agent has quadratic utility. Its formula is E[R₁] - R£= B: (E[RM] - Rf)< where E(RM) is the expected gross return of market portfolio, which we calculate in part (b), and B; is a measure of systematic risk for security i. The formula says that the expected risk premium of any security is proportional to its measure of systematic risk B₁. Calculate the beta of the security with payoff (1,0).<