Question

34. The annualised market risk premium is 5% and has annualised volatility of 22.36%. A friend of yours, who is a mean-variance utility maximiser, invests 50% of their portfolio in the market portfolio and 50% of their portfolio in the risk-free asset is 3% p.a.. You can infer that your friend’s risk aversion coefficient, A, is closest to:

Answer 1

Ans - Risk aversion coefficient is always positive i.e 0.5 because when an investor is mean variance utility maximiser, An risk averse investor has always positive coefficient .In this an investor is allocating 50% to risk free asset and remaining 50% in risky asset. The utility equation is

U = E(r) - 0.5 *A * standard deviation ²

Risk aversion coefficient for risk neutral is always 0 because he only cares about return

Risk aversion coefficient for risk lover is always negative.