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Consider the following tow, completely separate economies. The expected return and volatility of all stocks in both economies is the same.

Consider the following tow, completely separate economies. The expected return and volatility of all stocks in both economies is 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 others stocks. Assuming you are risk-averse and you could choose one of the two economies in which to invest, which one would you choose? Explain.

This question was asked on May 13, 2010.

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