Consider the following two, completely separate, economies. The expected return and volatility of all stocks in both economies is the same. In the first economy, all stocks move together—in good times all prices rise together and in bad times they fall together. In the second economy, stock returns are independent—one stock increasing in price has no effect on the prices of other stocks. Assuming you are risk-averse and you could choose one of the two economies in which to invest, which one would you choose? Explain.
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