Question

You invested $1000 in a risky asset with an expected rate of return of 017 and standard devation of 040 and a T- bill with a rate of return of 0.04

What is the weight you should put into risky asset to have optimal portfolio if yoyr coeficient of risk aversion A= 4?

Thank you,

Answer 1

The weight you should put into risky asset to have optimal portfolio if your coefficient of risk aversion A = 4

The weight you should put into risky asset = (Er – rf)/ (A *σ^2)

Where,

Expected return of risky asset = Er = 17% or 0.17

Return of risk-free asset = rf = 0.04

Standard deviation of risky asset = σ = 40% or 0.40

Coefficient of risk aversion is A = 4

Therefore,

The weight you should put into risky asset = (0.17 – 0.04)/ (4* (0.40)^2)

= 0.13 / 0.64 = 0.2031 or 20.31%

Therefore weight you should put into risky asset is 20.31% of total investment of $1000.