Hello Professor,
on this exercise, why can't we simply use the CML formula to find the std dev of the market? We have everything to do so.
Hi Salvador,
Remember that the market portfolio is on the CML, but individual stocks are often (actually always) below the CML.
Let's prove it by contradiction:
Note that stocks cannot be over the efficient frontier. It means that if two stocks are on the CML, the efficient frontier would have to cross the CML twice, which we know is not possible.
Another way of seeing it is the following: Consider there are two stocks on the CML (and they have non-zero diversifiable risk and are not perfectly correlated). Then, I can always construct a portfolio above the CML by combining the two stocks and diversifying risk. Since no portfolio can lie above the CML, we cannot see two stocks on the CML.
Remember that the market portfolio is on the CML, but individual stocks are often (actually always) below the CML.
Let's prove it by contradiction:
Note that stocks cannot be over the efficient frontier. It means that if two stocks are on the CML, the efficient frontier would have to cross the CML twice, which we know is not possible.
Another way of seeing it is the following: Consider there are two stocks on the CML (and they have non-zero diversifiable risk and are not perfectly correlated). Then, I can always construct a portfolio above the CML by combining the two stocks and diversifying risk. Since no portfolio can lie above the CML, we cannot see two stocks on the CML.
Ok thanks