Chpt 10 Problem 20

In: Business and Management

Submitted By MontBlanc
Words 633
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The Facts Consider the following two, completely, separate, economies. The expected return and volatility of all stocks in both economies is the same. In the first economy, all stocks move together- in good times all prices rise together and in bad times, they fall together. In the second economy, stock returns are independent-one stock increasing in price has no effect on the prices of other stocks. Assuming you are risk-averse and could chose one of the two economies in which to invest, which one would you chose.
What Does Risk Averse Mean?
There are numerous ways to describe what risk averse means; however, an accurate description of a risk averse investor is primarily an investor when faced with two investments with a similar expected return (but different risks), will prefer the one with the lower risk. So this person prefers low risk over higher risk and that preference drives their decision making. With this in mind, great care must be taken to examine the facts set, not through my own eyes (perspective), but through the perspective of a person who is indeed risk averse. A risk-averse investor dislikes risk, and therefore will stay away from adding high-risk stocks or investments to their portfolio and in turn will often lose out on higher rates of return. Investors looking for "safer" investments will generally stick to index funds and government bonds, which generally have lower returns. This leads me to hypothesize that to get the correct answer to the question is merely a matter of ascertaining which economy presents the highest level of risk and then concluding that is the economy that the risk averse individual would not be comfortable in.
An Examination of the Facts For the sake of our discussion we will label the first economy, Economy A and the second economy, Economy B. According to the problem, Economy A is subject to…...

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