Problem 3 – Investor Heterogeneity

Problem 3 – Investor Heterogeneity
Assume there are two types of agents: I’d identical arbitrageurs with
rational E4 Z = Zandt = 14 andVN identical noise traders with
biased EN Z – Z + 8 andt = IN.
a) Solve for the equilibrium price in this economy.
b) On the same graph, plot the equilibrium price against o for the following cases:
a. Equal relative risk bearing capacity: VATA = VNIN:
b. Marginal investor is an arbitrageur:
-0 :
c. Marginal investor is a noise trader:
-0 .
c) Under what parameters are prices efficient? Optimistic? Pessimistic? need