Question

Suppose the risk-free is 5%, the average investor has a risk aversion co-efficient of A=2, and the standard deviation of the market portfolio is 20%. What is the equilibrium value of the market risk premium? What is the expected return on the market? If the average degree of risk aversion were 3 , what would be the market risk premium, and expected return?

Answer 1

To find the equilibrium value of the market risk premium, we need the expected return on the market. Without that information, we cannot calculate the market risk premium.

Step-by-step explanation:

To find the equilibrium value of the market risk premium, we need to use the formula:

Market Risk Premium = Risk Aversion Coefficient * (Expected Return - Risk-Free Rate)

In this case, the risk aversion coefficient is 2, the risk-free rate is 5%, and the expected return on the market is unknown. Without the expected return, we cannot calculate the market risk premium.

If the average degree of risk aversion were 3, the new market risk premium could be calculated using the same formula, just with a different risk aversion coefficient. The market risk premium and expected return would depend on the specific values assigned to the risk aversion coefficient and market conditions.