Example:Expected Returns Suppose you have r predicted the following returns for stocks C and T in three possible states of nature. What are the expected returns? State Probability C T Boom 0.3 0.15 0.25 Normal 0.5 0.10 0.20 Recession ?? 0.02 0.01 Rc=.3(.15)+.5(.10)+.2(.02)=.099=9.9% RT=.3(.25)+.5(.20)+.2(.01)=.177=17.7% 44 Example: Expected Returns n Suppose you have predicted the following returns for stocks C and T in three possible states of nature. What are the expected returns? RC = .3(.15) + .5(.10) + .2(.02) = .099 = 9.9% RT = .3(.25) + .5(.20) + .2(.01) = .177 = 17.7% State Probability C T Boom 0.3 0.15 0.25 Normal 0.5 0.10 0.20 Recession ??? 0.02 0.01