Making A Prompt Comment Discussion

Making A Prompt Comment Discussion
1-) (folake budale)
Consider the following two, completely separate economies. The expected return and volatility of all stocks in both economies are the same.
In the first economy, all stocks move together in good times all prices rise together and in bad times, they all fall together.
In the second economy, stock returns are independent-one stock increasing in price has no effect on the prices of other stocks.
Which economy would you choose to invest in?
Explain your rationale for your choice.
Making A Prompt Comment Discussion
I would invest in the economy in which stock returns are independent owing to the fact that risk can be diversified away in a large portfolio. If returns each year are independent, the volatility of the average annual return does decline with the number of years that we invest. Diversification can help an investor manage risk and reduce the volatility of an asset’s price movements (Berk et al., 2021). Remember, however, that no matter how diversified a portfolio is, risk can never be eliminated completely. When you diversify your investments, you reduce the amount of risk you’re exposed to in order to maximize your returns. Although, there are certain risks you can’t avoid, such as systematic risks, you can hedge against unsystematic risks like business or financial risks (Lioudis, 2021).
As explained by Berk et al. (2021), we can reduce systematic risk of a portfolio by selling stocks and investing in risk-free bonds, but at the cost of giving up the higher expected return of stocks. Thus, a large portfolio eliminates all unsystematic risk, leaving no additional risk. Since that portfolio has no risk, it cannot earn a risk premium, and instead must earn the risk-free interest rate. This goes with the general principle that “the risk premium for diversifiable risk is zero. Thus, investors are not compensated for holding unsystematic risk (Berk et al., 2021).
References
Berk, J., DeMarzo, P.,