Suppose the risk-free rate of return is 0.03. Market porfolio return is 0.10 and its risk measured by standard deviation is 0.05. There are two investors in the economy. Their expected utility functions are given by: Eu = r − s2/ti, for i = 1, 2,where risk tolerance t1 = 1 and t2 = 0.5.
1. Derive the Sharpe ratio of the market portfolio. Is there a stock in the market that can beat this Sharpe ratio?
2. Derive the two individual investors’ portfolios. What are the expected return and risk of each individual investor’s choice? Comment.
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