Question
In: Economics
The price of risk measures how risk and return can be traded off in making portfolio...
The price of risk measures how risk and return can be traded off
in making portfolio choices. Assume that the standard deviation of
a risky asset is 2.00% (and does not change) with a return of
8.00%. You also have the choice to invest in a risk-free asset with
return 4.00%.
If the risk-free return increases by 1.00 percentage points and the
risky asset return increases by 7.00 percentage points, what is the
change in the price of risk (in percentage
points)? (Round to two decimals, if
necessary.)
HINT: Recall that the price of risk is the difference in returns from a risky asset compared to a risk-free asset relative to the standard deviation of the risky asset.
Solutions
Expert Solution
Market price of Risk = Expected return - Risk free return/ Standard deviation
Originally market price of risk was = (8-4)/2 = 2 units
Now in new market conditions we have
Market Price of Risk = (15-3)/2 = 7.5 units
hence % change in price of risk = (7.5-2)/2 = 275 percentage points
Rahul Sunny answered 1 year agoRelated Solutions
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