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QUESTION

A put option is a highly volatile security. If the underlying stock has a positive beta, then a put option on that stock will have a negative beta.

A put option is a highly volatile security. If the underlying stock has a positive beta, then a put option on that stock will have a negative beta. According to the CAPM, an asset with a negative beta, such as the put put option, has an expected return below the risk free rate. How can an equilibrium exist in which a highly risky security such as a put option offers an expected return below a much safer security such as a treasury bill?

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