Problem
Consider an economy with two types of firms, S and I. S firms all move together. I firms move independently. For both types of firms, there is a 60% probability that the firms will have a 15% return and a 40% probability that the firms will have a -10% return. What is the volatility (standard deviation) of a portfolio that consists of an equal investment in 20 firms of (i) type S, and (ii) type I?
i. Standard Deviation of 20 firm of Type S =
ii. Standard Deviation of 20 firm of Type I =
Using the data in problem, plot the volatility as a function of the number of firms in the two portfolios.