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Probability of State of Economy State of Economy Recession .20 Normal .60 .20 Irrational exuberance Rate of Return if State Occurs Stock I Stock II

Probability of State of Economy State of Economy Recession .20 Normal .60 .20 Irrational exuberance Rate of Return if State Occurs Stock I Stock II .035 .345 .205 -.35 .27 .45 The market risk premium is 11.5 percent, and the risk-free rate is 4.5 percent

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