return, 9.5%; standard deviation, 20.1%. a. To the extent that these averages approximated investor expectations for the period, what must have been the average coefficient of risk aversion? b. If the coefficient of risk aversion were actually 3.5, what risk premium would have been con- sistent with the markets historical standard deviation?     Expected Returns on Individual Securities   The CAPM is built on the insight that the appropriate risk premium on an asset will be de- termined by its contribution to the risk of investors overall portfolios. Portfolio risk is what matters to investors and is what governs the risk premiums they demand. III. Equilibrium In Capital Markets 9. The Capital Asset Pricing Model The McGraw−Hill Companies, 2001           268 PART III Equilibrium in Capital Markets     Remember that all investors use the same input list, that is, the same estimates of ex- pected returns, variances, and covariances. We saw in Chapter 8 that these covariances can be arranged in a covariance matrix, so that the entry in the fifth row and third column, for example, would be the covariance between the rates of return on the fifth and third securi- ties. Each diagonal entry of the matrix is the covariance of one securitys return with itself, which is simply the variance of that security. We will consider the construction of the input list a bit later. For now we take it as given. Suppose, for example, that we want to gauge the portfolio risk of GM stock. We mea- sure the contribution to the risk of the overall portfolio from holding GM stock by its co- variance with the market portfolio. To see why this is so, let us look again at the way the variance of the market portfolio is calculated. To calculate the variance of the market port- folio, we use the bordered covariance matrix with the market portfolio weights, as dis- cussed in Chapter 8. We highlight GM in this depiction of the n stocks in the market portfolio.     Portfolio Weights w1 w2 . . . wGM . . . wn