Suppose an investor equally allocates their wealth between a risk-free asset and a risky asset. If the MRS of the current allocation is less than the slope of the budget line, then the investor should:
A) shift more of their wealth to the risky asset.
B) shift more of their wealth to the risk-free asset.
C) keep the same asset allocation.
D) We do not have enough information to answer this question.

Question

Quizplus · Accepted Answer

When the Marginal Rate of Substitution (MRS) of the current allocation is less than the slope of the budget line, it indicates that the investor values the risky asset's return more than the risk-free asset's return, relative to their respective risks. Therefore, the investor should shift more of their wealth to the risky asset to increase utility.

Suppose an Investor Equally Allocates Their Wealth Between a Risk-Free