Suppose a small country has two sectors. One is called consumer staple, which primarily services domestic households. For example, companies in this sector sell household items such as toilet papers and cooking oil to domestic households. Another sector is called export sector, which exports most of its products in the international market. In the consumer staple, the wage is h; in the export sector, the wage is e. h and e are random variables that capture the uncertainties in wage from macroeconomic conditions and idiosyncratic factors specific to their respective sector. There are two foreign stock markets, A and B, where returns are r and k, respectively. Each household has one unit of labor and one unit of capital. A household's income is a sum of its labor income and capital income. We also know the following: Cov(h, r) = Cov(e, k) = 0.22 Cov(h, k) = Cov(e, r) = 0.20 Var(r) = 0.33 Var(k)= 0.36 E(r) = E(k)= 0.05 Households have diminishing marginal utility and are risk-averse. Households could either all of their capital in stock market A or all of their capital in stock market B. Which of the following statements best described what we discussed in the course? O Households in the consumer staple sector should invest in stock market A because its return has a lower variance. Households in the consumer staple sector should invest in stock market B because its return has a lower variance. Households in the consumer staple sector should invest in stock market B because it leads to a lower variance of total income. O Households in the export sector should invest in stock market B because stock market B is less risky.
