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As a risk averse investor, in which economy would you choose to invest?

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Could you please provide a report well supported, in APA format, illustrated with examples about your conclusions in this case study:

Diversification in Stock Portfolios

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 all fall together. In the second economy, stocks returns are independent; one stock increasing in price has no effect on the prices of other stocks. Assuming you are risk averse and you could choose one of the two economies in which to invest, which one would you choose? Explain.

References: Corporate Finance The Core, Second Edition by Jonathan Berk and Peter DeMarzo.

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Solution Summary

This solution discusses two different economies an investor could invest in, identifies sources of risk, and provides hypothetical calculations for expected return and standard deviation for two different portfolios to help strengthen the students understanding of diversifying non-systematic risk through holding different types of stock.. This solution is 927 words with six references and in-text citations.

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You are a risk-averse investor who is considering investing in one of two 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 all fall together.
In the second economy, stock returns are independent-one stock increasing in price has no effect on the prices of other stocks.
Which economy would you choose to invest in? Explain and illustrate with examples.
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In the investment domain, risk is the uncertainty about future returns (Damodaran, 2002). The greater this uncertainty, the more risky an investment is perceived to be. It refers to the likelihood of receiving a return on an investment that is different from the expected rate of return (Bodie et al, 2004). In includes both upside risk i.e. returns that are higher than expected and downside risk i.e., returns that are lower than expected.

According to the mean-variance analysis of Markowitz (1952), investors not only care about the mean of their returns but also the variance (risk) of their returns. Thus, a risk-averse investor when given a choice between two assets with equal rates of return but with different levels of risk would select the asset with the lower level of risk. The prior empirical research in the area of investments under risk aversion have indicated that an investor with high risk aversion will choose a more diversified portfolio in order to minimize the risk of their portfolio (Friend and Blume, 1975). However, the actual choice would depend upon the individual's risk tolerance. Depending upon the risk tolerance, there would ...

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