Question: Suppose we have an economy with 1 commodity, two possible states, and two consumers, and no trades at Date 0. Agent 1 is risk-neutral (i.e., Agent l's utility function satisfies: u'' (x) = 0) while Agent 2 is risk-averse (u'' (x) < 0).
Assume:
1a) Derive the equilibrium price ratio of the contingent claims contract for this economy.
1b) Is there a value for the probability π, such that can Agent 2 achieve complete insurance in equilibrium? If so, describe how it will be achieved. What is the value of π, in this instance? (Hint: Try π = .25).
1c) What assumption did we make in this problem that was key to the result you obtained in la) and lb)? Explain.