Question: In one year the economy could be in one of three possible states: bust, normal, or boom with corresponding probabilities of 0.25, 0.5 and 0.25.

In one year the economy could be in one of three possible states: bust, normal, or boom with corresponding probabilities of 0.25, 0.5 and 0.25. The returns on a common stock A and the market portfolio M conditional on the state of the economy are presented in the table below. Assuming CAPM holds in the economy, calculate the market risk premium over the period.

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