Suppose the probabilities of the recession or boom are .30, while the probability of a normal period is .40. would you expect the varaince of returns on these 2 investments to be higher or lower?

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12-09-2022
Business

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Suppose the probabilities of the recession or boom are .30, while the probability of a normal period is .40. would you expect the varaince of returns on these 2 investments to be higher or lower?

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devikabalrajan devikabalrajan · Answer 1 · 2022-09-17T15:40:08+02:00

The standard deviation should decrease because there is now a lower probability of the more extreme outcomes. The expected rate of return on the auto stock is now

How is the variance calculated?

[0.3 × (–8%)] + [.4 × 5%] + [.3 × 18\%] = 5%[.3×(–8%)]+[.4×5%]+[.3×18%] = 5%

The variance is

[.3× (–8 – 5[tex])^2[/tex]] + [.4× (5 – 5[tex])^2[/tex]] + [.3×(18 – 5[tex])^2[/tex]] = 101.4

The standard deviation is √101.4 = 10.07 percent, which is lower than the value assuming equal probabilities of each scenario.

To learn more about variance, refer

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