Question:
Consider an asset allocation problem faced by an investor who has $1 million to allocate between a stock index and a money market fund. Suppose that the investor believes that the stock index has an annual expected return of 12% with 20% risk. The risk-free interest rate is 3% per year.
1. If the investor has a quadratic utility with risk-aversion parameter ? =3, what will be the asset allocation decision?
2. What is the risk and return of the investor"s optimal portfolio?
3. If for a portfolio risk of 15%, the investor desires a level of expected return of 9.75%, what is the implied risk-aversion parameter?