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single_factor_model - Single Factor Model Ri = E(Ri iF e i...

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Single Factor Model R i = E(R i ) + ß i F + e ß i = index of a securities’ particular return to the factor F= some macro factor; in this case F is unanticipated movement; F is commonly related to security returns Assumption: a broad market index like the S&P500 is the common factor
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Single Index Model Risk Premium Risk Premium Market Risk Premium Market Risk Premium or Index Risk Premium or Index Risk Premium i = the stock’s expected return if the = the stock’s expected return if the market’s excess return is zero market’s excess return is zero ß ß i (r (r m - r - r f ) ) = the component of return due to = the component of return due to movements in the market index movements in the market index (r (r m - r - r f ) ) = 0 = 0 e e i i = firm specific component, not due to market = firm specific component, not due to market movements movements α ( 29 ( 29 e r r r r i f m i i f i + - + = - β α
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Let: R Let: R i i = (r = (r i - r - r f ) ) R R m m = (r = (r m - r - r f ) ) Risk premium Risk premium format format R R i i = = α α i + ß + ß i (R (R m ) ) + e + e i Risk Premium Format Risk Premium Format
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