Assume that there are two stock markets with one common factor F, where E(F) = 0 and F = 15%. There are many securities

Assume that there are two stock markets with one common factor F, where E(F) = 0 and σ_F = 15%.  There are many securities in each market.

The return on a security, i, in market 1 is:

 

R_1i = 0.15 + 1.5F + e_1i  

 

The return on a security, j, in market 2 is:

 

R_2j = 0.12 + 1.1F + e_2j  

 

Where E(e_1i) = E(e_2j) = 0, σ_e1i =  σ_e2j = 20%. 

 

If you have to choose one of the two markets, and if the correlations of unsystematic risk between two assets are 0 for the market 1 and 0.85 for the market 2, which market do you invest? Why?