EC3314, Fall 2015 Essay

| January 6, 2016

EC3314, Fall 2015 Essay
Due at noon, Monday, January 11th, 2016 on Turnitin
We often hear that information is crucial to investors in the financial market. Comment on the role of
information in the asset pricing models we saw in class.
Details:
Your essay should have up to 1000 words, and should be submitted on Turnitin either in word or in pdf
format.
For each of the asset pricing models we saw in class (CAPM, APT, DDM), your essay should describe
the assumptions about what information investors have on the available assets, addressing the
following four questions:
– What information does each model assume is available to investors?
– Describe how this information is used in the pricing equations in each model?
– In the mean-variance (Markowitz) framework, show that the value for an investor of
information that reduces the standard deviation of the optimal risky portfolio from ??! to
??! < ??! is proportional to the share of wealth assigned to P times the percentage change in
variance.
– Show that this implies that information about variance is more valuable to less risk averse
investors. Explain the intuition behind this result.
– What is the prediction of CAPM and APT regarding investor demand for information in
equilibrium: should an individual investor try to get information if doing so is costly?
– Based on your knowledge of market intermediaries – e.g. banks, mutual funds, brokers – and
the services they provide, assess whether this is a good description of the demand for
information in the real world. Comment on the assessment in light of the efficient market
hypothesis.
NOTE: your essay should focus on the issues above. Using space with discussions of other issues with
be penalized. You are encouraged to draw from the BKM textbook.

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