You are a risk-averse investor who is considering investing in one of two economies. The expected return and volatility of all stocks in both economies is the same. In the first economy, all stocks move togetherlong dash-in good times all prices rise together, and in bad times they all fall together. In the second economy, stock returns are independentlong dash-one stock increasing in price has no effect on the prices of other stocks. Which economy would you choose to invest in?

Question

Business

Lyric Osborne

8 October, 06:01

You are a risk-averse investor who is considering investing in one of two economies. The expected return and volatility of all stocks in both economies is the same. In the first economy, all stocks move togetherlong dash-in good times all prices rise together, and in bad times they all fall together. In the second economy, stock returns are independentlong dash-one stock increasing in price has no effect on the prices of other stocks. Which economy would you choose to invest in?

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Answers (1)

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Maren Barker · Answer 1

It's best to invest in the second economy

Explanation:

The question does not provide information on the hypothetical economic expectations of the two economies, but as a risk-averse investor, it's a better idea to try to "spread" the risk instead of concentrating it.

In the first economy, conditions might or might not be good. If they are good, returns will be extraordinary because all stocks will provide good returns, but if conditions take a turn for the worse, all stocks prices will fall and the financial consequences will be catastrophic.

In the second economy, results might never be as good as in the first economy, but they also will not ever be as bad. The risk is spread between various stocks, and while some may fall in price, others will rise, and viceversa. For a risk-adverse investor, this a far better option.