Mean–Variance Analysis
A risk-averse investor can choose between three portfolios with the following measured returns and risk:
| Portfolio | Mean Return | Standard Deviation |
|---|---|---|
| 1 | 8% | 18% |
| 2 | 10% | 18% |
| 3 | 10% | 15% |
Which portfolio will the investor _most likely_ choose?
Correct!
Since Portfolios 1 and 2 have the same standard deviation but Portfolio 2 has a greater mean return, Portfolio 2 will be preferred to Portfolio 1. Portfolios 2 and 3 have the same mean return, but Portfolio 3 has a lower standard deviation of returns, making it less risky. Therefore, Portfolio 3 will be preferred to Portfolio 2, which itself will be preferred to Portfolio 1.
Incorrect.
Portfolios 1 and 2 have the same standard deviation, but Portfolio 2 has a higher mean return. Therefore, for the same risk, Portfolio 1 has a lower mean return.
Incorrect.
Portfolios 2 and 3 have the same mean return, but Portfolio 2 has a higher standard deviation, making it riskier for the same mean return.
Portfolio 1
Portfolio 2
Portfolio 3
