Consider a risky portfolio that offers a rate of return of 15% per year with a s

Question

Consider a risky portfolio that offers a rate of return of 15% per year with a standard deviation of 20% per year. Suppose an investor is indifferent between investing in the risky portfolio and investing in a risk free asset earning 8% per year.
a) What is the investor's risk aversion coefficient?
b) If allowed to invest in a combination of the risky portfolio and the risk free asset, what proportion would the investor hold in the risky portfolio?
c) What is the expected rate of return and the standard deviation of the rate of return on the optimally chosen combination?
d) What would be the investor's certainty equivalent return for the optimally chosen combination?

Explanation / Answer

Answer a)

What is the investor's risk aversion coefficient?

In modern portfolio theory, risk aversion is measured as the additional marginal reward an investor requires to accept additional risk.

Investor's risk aversion coefficient = (Rate of return of risky portfolio – Rate of Return of risk free asset) / (Standard deviation of risky portfolio – Standard deviation of risk free assets)

= (15 % - 8 %) / (20% - 0%)

= 7% / 20%

= 0.35

Answer : The investor's risk aversion coefficient is 0.35

Related Questions

Navigate

• Browse (All)
• Browse C
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.