1. Business
  2. Finance
  3. if investors are varianceaverse they hold the market portfolio which...

Question: if investors are varianceaverse they hold the market portfolio which...

Question details

If investors are variance-averse they hold the market portfolio, which predicts that πΈπ‘Ÿπ‘– βˆ’ π‘ŸπΉ = πΆπ‘œπ‘›π‘ π‘‘π‘Žπ‘›π‘‘ βˆ— πΆπ‘œπ‘£(π‘Ÿπ‘– , π‘Ÿπ‘€) , where πΈπ‘Ÿπ‘– is the expected return on stock 𝑖; π‘ŸπΉ is the risk free return; and πΆπ‘œπ‘£(π‘Ÿπ‘– , π‘Ÿπ‘€) is the covariance between the return of the stock and the return on the market index. Suppose the stock market consists of only 2 stocks A and B and a risk-free asset. Let πΈπ‘Ÿπ΄ = 10%; πΈπ‘Ÿπ΅ = 8%; π‘ŸπΉ = 4%; the variance of A is π‘‰π‘Žπ‘Ÿ(π‘Ÿπ΄ ) = 0.20; the variance of B is π‘‰π‘Žπ‘Ÿ(π‘Ÿπ΅) = 0.15; and the covariance between A and B is πΆπ‘œπ‘£(π‘Ÿπ΄, π‘Ÿπ΅) = 0.40. What is the composition of the market index?

Solution by an expert tutor
Blurred Solution
This question has been solved
Subscribe to see this solution