Attached are monthly returns over the past decade for every public equity firm in the US. The objectives of this exercise are to 1) compare the risk-reward relationship of individual securities in the US market to the risk-reward relationship of the US stock market portfolio and 2) gain a better understanding of diversification.
1. For each month, calculate the return to the board market portfolio that is equally invested in all securities.
2. Calculate the expected return and standard deviation for each security and the market portfolio.
3. Calculate the average expected return of the securities and the average standard deviation of the securities. Compare this to the market's expected return and standard deviation.
- Is the expected return of the market the same as the average expected return of the securities?
- Is the standard deviation of the market less than the average standard deviation of the securities? If not, which one is lower?
- Compare the results of questions (1) and (2). What explains these results?
- As an investor, what's the implications of 3?