Question

company A expected return = 0.12 std. dev = 0.4 Beta = 1.5 company B expected...

company A expected return = 0.12 std. dev = 0.4 Beta = 1.5 company B expected return = 0.11 std. devation = 0.18 beta = 0.8 risk free rate = 0.01 market return = 0.07

If the correlation coefficient between stock A and the market is 0.75, what is the market price of risk? which stock has a higher proportion of idiosyncratic risk?

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Answer #1

Market price of risk is a measure of excess return or extra return. For eg:- Sharpe ratio.

Sharpe ratio of company A = return - risk free rate / standard deviation

= 0.12 - 0.01 / 0.4

= 0.11 / 0.4

= 0.2750

Sharpe ratio of company 2 = return - risk / standard deviation

= 0.11 - 0.01 / 0.18

= 0.10 / 0.18

= 0.56

b) Idiosyncratic risk refers to unsystematic risk which is measured by standard deviation. Company A has higher standard deviation which means that it has higher proportion of idiosyncratic risk.

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