Both the variance and standard deviation show the dispersion in returns from the average. The variance’s units, dollars squared or percent squared, are not intuitive to most users. The square root of the variance (σ2).50, the standard deviation (σ), has units of dollars or percent. If the returns are normally distributed, about 68 percent of the observed return should fall within one standard deviation of the average return; 95 percent should fall within two standard deviations; 99 percent should fall within three standard deviations. Thus, the standard deviation gives the user an idea of the range of the data.
Discuss the questions/statements below:
1. What is meant by the coefficient of variation? How is it used as a measure of risk?
2. Explain the terms diversification and correlation in the context of forming portfolios.
3. Describe the meaning of a “state of nature” and explain how this concept is used to provide expected measures of return and risk.
4. What are the differences among the weak, semi strong, and strong forms of the efficient market hypothesis?