Question 5.

Use a diagram to help explain how expected returns and risk are traded off in portfolio choice. Include the effect of the availability of a risk-free asset. Briefly discuss the meaning of the curves and the equilibrium. Then

a) use your diagram to help explain how portfolio behaviour changes when asset risks become more correlated,

b) illustrate on the diagram a measure for the change in the portfolio share of the risk free asset, and

c) briefly discuss the implication of this behaviour for macroeconomic performance during financial crises.