Question

Following the COVID crisis, the economy is highly uncertain, and the level of next year's aggregate consumption will depend on the strength of the economic recovery. Consider two possibilities: either the recovery will be strong (S)and consumption will grow by 10%, or the recovery will be weak (W)and consumption will fall by 10%. Economists predict that the likelihood of a strong recovery is 70%. Assuming that the representative investor has log utility and a subjective discount factor equal to \beta = 0.99, you want to determine the price of financial assets in the current economic environment. What would be the risk-free rate?

          Following the COVID crisis, the economy is highly uncertain, and the level of next year's aggregate consumption will depend on the strength of the economic recovery. Consider two possibilities: either the recovery will be strong (S)and consumption will grow by 10%, or the recovery will be weak (W)and consumption will fall by 10%. Economists predict that the likelihood of a strong recovery is 70%.
Assuming that the representative investor has log utility and a subjective discount factor equal to \beta = 0.99, you want to determine the price of financial assets in the current economic environment.
What would be the risk-free rate?

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Added by Marcus R.

Principles of Economics

Gregory Mankiw 8th Edition

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Solved by Expert Shilpi Arora

04/27/2021

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Following the COVID crisis, the economy is highly uncertain, and the level of next year's aggregate consumption will depend on the strength of the economic recovery. Consider two possibilities: either the recovery will be strong (S)and consumption will grow by 10%, or the recovery will be weak (W)and consumption will fall by 10%. Economists predict that the likelihood of a strong recovery is 70%. Assuming that the representative investor has log utility and a subjective discount factor equal to \beta = 0.99, you want to determine the price of financial assets in the current economic environment. What would be the risk-free rate?

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Transcript

00:02 This problem is based on consumption from macro economics.

00:07 Both in this problem by using others equation for consumption we will calculate different values step by step.

00:19 As for the problem.

00:21 In part 1st we have to yes find out the coat rate.

00:42 Yeah full consumption.

00:51 Mhm.

00:54 We have given some values that is entrust rate really interested.

01:00 Or we can write this are that is five and vita that is one.

01:11 We have to calculate growth rate four what consumption by using others equation vita multiplied by one plus are minus one.

01:38 By putting the values.

01:40 Vita is one, multiplied by one plus r.

01:44 That is 5%.

01:45 Or we can write the 0.5 minus one.

01:49 Bye solving this.

01:51 We will get the growth rate for consumption one.

01:56 Yeah.

01:59 Mhm .05 -1.

02:06 That is 0.05.

02:10 Or we can write this fight percent.

02:17 Does the growth rate for consumption? will household choose is 5%.

02:23 Now coming to the next part in this we have to determine the crow trade for consumption.

02:34 Will household choose if beat us is 0.9 five now according to the others equation one can calculate the growth rate for consumption if vida is equal to 0.95...

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