Question
Suppose you manage a risky fund with expected return E[rP ] = 11% and standard deviation P = 15%. Your client, a mean-variance optimizer with
Suppose you manage a risky fund with expected return E[rP ] = 11% and standard deviation P = 15%. Your client, a mean-variance optimizer with coefficient of risk aversion A, wants to invest a proportion of wealth into your risky fund and a proportion borrowing or lending. However, the client faces different interest rates for borrowing versus lending. If the client lends, they can receive the risk-free rate of rf = 5%. If the client borrows, they must pay a borrowing rate of r B f = 9%. (This is a kinked capital allocation line.) What is the range of risk aversion A for which your client would neither borrow nor lend (that is, for which = 1)? Suppose A = 0.8. What is the clients optimal portfolio?
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