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#titleAssignment Help.., Financial Econometrics

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Question I: (50 points)
Derive the pricing formula for the expected excess return of a risky stock and the riskfree stock in the traditional consumption-CAPM assuming that the level of habit Ht depends on the time t-1 agent’s and the society consumption levels (Ct?1 and Ct?1), that is:
H =C?1 C?2
t t?1 t?1
were ?1 and ?2 are elasticities of Ht with respect to Ct?1 and Ct?1 (constant parameters).

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In a market where the CAPM holds there are five risky assets with the following attributes per year.
Asset 12345 Expected return 5% 3% ?1% 6% 0% Market capitalisation (in millions of $) 2.2 3 4.6 1.2 5
0B1 2 0.5 0.6 0.81C
B 2 40 8.8 ?13.8 ?2.6 C ?=B 0.5 8.8 17.94 ?0.75 ?2.51 C @ 0.6 ?13. 8 ?0.75 17. 153 0.035 A
0.8 ?2. 6 ?2. 51 0.035 5. 74
1- Calculate the expected return on the market portfolio and the market risk assuming that the portfolio weights are equal.
2- Calculate the expected return on the market portfolio and the market risk assuming that the portfolio weights are proportional to the asset’s market capitalisation.
3- Calculate the expected return on the market portfolio and the market risk using mean-variance model.
4- Which of the three strategies is the best.
5- Do 1, 3 and 4 assuming that the risk-free rate is r = 1% with a weight wf = 0.2.

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