2. Statistical measures of standalone risk Aa Aa Remember, the expected value of a probability distribution is a statistical measure of the average (mean) value expected to occur during all possible circumstances. To compute an asset's expected return under a range of possible circumstances (or states of nature), multiply the anticipated return expected to result during each state of nature by its probability of occurrence Consider the following case: Aaron owns a two-stock portfolio that invests in Celestial Crane Cosmetics Company (CCC) and Lumbering Ox Truckmakers (LOT). Three-quarters of Aaron's portfolio value consists of CCC's shares, and the balance consists of LOT's shares. Each stock's expected return for the next year will depend on forecasted market conditions. The expected returns from the stocks in different market conditions are detailed in the following table: Market Condition Probability of occurrence Celestial Crane Cosmetics Lumbering Ox Truckmakers Strong 25% 38% 53% Normal 45% 23% 30% Weak 30% 30% 38% Calculate expected returns for the individual stocks in Aaron's portfolio as well as the expected rate of return of the entire portfolio over the three possible market conditions next year. The expected rate of return on Celestial Crane Cosmetics's stock over the next year is 14.65% The expected rate of return on Lumbering Ox Truckmakers's stock over the next year i 9.22% The expected rate of return on Aaron's portfolio over the next year is 13.02% 10.85% The expected returns for Aaron's portfolio were calculated based on three possible conditions in the market. Such conditions will vary from time to time, and for each condition there will be a specific outcome. These probabilities and outcomes can be represented in the form of a continuous probability distribution graph