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4. Consider a one-factor economy. Suppose the market index is a well-diversified portfolio with expected return 10% and that deviations of its return from
4. Consider a one-factor economy. Suppose the market index is a well-diversified portfolio with expected return 10% and that deviations of its return from expectation (i.e. the market shock) can serve as the systematic factor. The T-bill rate is 4%, which implies that the market risk premium is 6%. Now another well- diversified portfolio E with a beta of 2/3, what is the expected return for E? if its expected return actually is 9%? Will there be arbitrage opportunity? What's your trading strategy?
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