Question

Consider the following four stocks: Stock Expected Return (E[r]) Standard Deviation A 0.12 0.30 B 0.15 0.50 C 0.21 0.16 D 0.25 0.21 1) According to the mean-variance dominance principle, which stock a rational and risk-averse investor will choose from stocks A, B and C? How does this choice compare with stock D?

Answer 1

According to the Principal of Dominance,

We will choose the following stocks

a) High return, High risk

b) Same return, low risk

c) Same risk, High return

Given that

	A	B	C	D
Return	0.12	0.30	0.15	0.50
Risk	0.21	0.16	0.25	0.21

After applying the above principal and comparing the stocks of A, B and C, we could find that the stock A and C has high risk with lower return compared to stock B.

Hence Stock B shall be selected which has Return of 0.30 and risk of 0.16.

The stock D has return of 0.50 and risk of 0.21.

By analysing the above two stocks, it will be unfair to compare both the stocks because both stocks has different return and risk.

Conclusion: -

1. By comparing the stock A, B, C, "Stock B" is recommended.

2. By comparing the Stock B and D , Both the stocks are recommended