Expected Return Prob Qn

Discussion in 'P1.T2. Quantitative Methods (20%)' started by Jiew Kwang, Dec 4, 2010.

  1. Jiew Kwang

    Jiew Kwang Member

    Hi guys,

    Anyone can figure the intuition behind this question?

    Consider two stocks A and B. Assume their annual returns are jointly normally distributed, the
    marginal distribution of each stock has mean 2% and standard deviation 10%, and the correlation is
    0.9. What is the expected annual return of stock A if the annual return of stock B is 3%?
    a. 2.9%
    b. 2%
    c. 1.1%
    d. 4.7%


    CORRECT: A
    E[ra | rb = x] = μa + (ρab σaσb/σa)(x – μb) = 0.02 + 0.9 * (0.03 – 0.02) = 0.029

    Reference: Damodar Gujarati, chapter 2.

    Thanks and regards,
    jk

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