Question

Consider a portfolio that offers an expected rate of return of 10% and a standard deviation of 24%. T-bills offer a risk-free 6% rate of return.

What is the maximum level of risk aversion for which the risky portfolio is still preferred to T-bills?

Answer 1

Calculate the maximum level of risk aversion as follows:

Utility function = Expected rate - 0.5 *Aversion * Standard deviation^2

6% =10% - 0.5 * Aversion * 24%^2

Aversion = (10% - 6%)/(0.5*0.0576)

= 1.39

Therefore, the maximum level of risk aversion is 1.39.