The president of the United States is considering two different candidates to ch

Question

The president of the United States is considering two different candidates to chair the Federal Reserve. If he chooses Alan, the probability that inflation will be 2 percent is 0.4 and the probability that inflation will be 4 percent is 0.6. If the president chooses Ben, the probability that inflation will be 2 percent is 0.6 and the probability that inflation will be 3 percent is 0.4. If you are an investor with your funds invested in bonds paying 7 percent, calculate the coefficient of variation of your real return if Alan is chosen to chair the Fed and if Ben is chosen to chair the Fed. Which candidate would you prefer if you are risk averse? Show calculations.

Explanation / Answer

Coefficient of Variation Cv = Standard Deviation / Mean

Probality Inflation

Alan 2% 0.4

4% 0.6   

Ben 2% 0.6

3% 0.4   

Funds invested in Bonds paying = 7%

I Observe that coefficient of variation for ALAN and BEN is 0.28 and 0.51 , This indicates Ben is more suitable to chair the Federal Reserve.

Probability 1 2 3 4 Standard Deviation Mean Coefficient of Variation alan Inflation 0.3 0.4 0.5 0.6 0.129099445 0.45 0.286887655 Ben Inflation 0.8 0.6 0.4 0.2 0.25819889 0.5 0.516397779

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