Assume a fictitious world where there are four stocks:

General Electric (GE)

CitiGroup (C)

British Petroleum (BP)

FaceBook (FB)

The market is in equilibrium where CAPM assumptions hold (e.g. homogeneous expectations, efficient markets, zero transaction costs, etc.)

Express the equilibrium condition for this universe of stocks in terms of each stock's return contribution and risk contribution. For notation purposes, you can use the symbols r_mkt & σ_mkt to represent the market's return & risk and r_f to represent the risk-free rate.

 

2. Describe in words, the equilibrium relationship from Question. 

 

3. What would be the market's response if the ratio of the contribution to the market's risk premium divided by the contribution to the market's variance is higher for BP and lower for FB vs. the other two stocks? 

Answer rating: 100% (QA)

1 The equilibrium condition for this universe of stocks in terms of each stocks return contribution and risk contribution can be expressed as rGE rf G... View the full answer