nStandard statistical measures of risk

nStandard statistical measures of risk - +40% +20% +40%...

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n Standard statistical measures of risk: Variance = Expected value of [r(market realized) - r(market expected)]^2 Standard deviation = sqrt(variance) HH +40% HT +10% TH +10% TT -20% Variance=.25*(.3)^2+.25*(.3)^2 = .045 Standard deviation=sqrt(.045)=.212=21.2% Estimating risk: Suppose we flip coins: THTTTTHTTHTHTTHTHTHH or: 10%, -20%, -20%, 10%, 10%, 10%, -20%, 10%, 10%, 30% average:3%, Std Dev: 17.03% Our estimates are only estimates, and are far from being perfect. .. Diversification and risk: "State of the World" Universal Utility Mega Manufacturing Simple Service Exciting Exports Startup Semiconductor HH +20%
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Unformatted text preview: +40% +20% +40% +20% HT +0% +10% +5% +50% -20% TH +10% +10% +5% -30% -20% TT -10% -20% -10% -20% +20% $100 in Mega Manufacturing: Expected Return=10% ($10); Std Dev=21.2% $50 in Mega, $50 in Universal Utility: Expected Return=7.5% ($7.5); Std Dev=16.0% $25 in Mega, $25 in Simple, $25 in Exciting, $25 in Startup: Returns are (30%, 11.25%, -8.75%, 12.5%) Expected Return=6.25% ($6.25), Std Dev=14.6% [Average all five: $20 in each; 28%, 9%, -5%, -10%; expected return 5.5%, std dev 12.7%] Why does diversification reduce risk? Because stocks do not all move together. .....
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