Reference no: EM132769747

Greta has risk aversion of = 5 when applied to return on wealth over a . She is pondering two portfolios, the S&P 500 and a hedge fund, as well as a number of one-year strategies. (All rates are annual and continuously compounded.) The S&P 500 risk premium is estimated at 8% per year, with a standard deviation of 14%. The hedge fund risk premium is estimated at 10% with a standard deviation of 29%. The returns on both of these portfolios in any particular year are uncorrelated with its own returns in other years. They are also uncorrelated with the returns of the other portfolio in other years. The hedge fund claims the correlation coefficient between the annual return on the S&P 500 and the hedge fund return in the same year is zero, but Greta is not fully convinced by this claim.

Problem 1: If the correlation coefficient between annual portfolio returns is actually 0.2, what is the covariance between the returns?