Question

Consider the following two stocks.

	Probabilities (pi )	Stock "a"	Stock "b"
Recession	p1= 31%	-4%	4%
Normal	p2= 26%	7%	-4%
Boom	p3= 43%	11%	26%

Expected Return

r¯a = 5.31

r¯b = 11.38

Standard Deviation

SDa = 6.44

SDb = 13.05

Question:

Using the correct answers from the previous questions, what is the covariance between the two stocks? Enter your answer rounded to 2 decimal places.

Cov(a, b) = ?

Answer 1

	Probability	Stock a	Stock b	Deviation Stock a	Deviation Stock b
Recession	31%	(4.00)	4.00	(9.31)	(7.38)
Normal	26%	7.00	(4.00)	1.69	(15.38)
Boom	43%	11.00	26.00	5.69	14.62

Covariance between Stock a and Stock b = Σ P*Deviation Stock a*Deviation Stock b

= 31%*(-9.31)*(-7.38)+26%*1.69*(-15.38)+43%*5.69*14.62

= 50.31