This preview shows pages 1–5. Sign up to view the full content.
Econ 333 Spring 081Factor Models and the Arbitrage Pricing Theory
has intentionally blurred sections.
Sign up to view the full version.
Econ 333 Spring 082Factor Models and the Arbitrage Pricing TheoryOur goals:•Be able to decompose the variance of an asset into market-related and non market-related components. i.e. common and firm-specific components.•Understand why variance decomposition is important for valuing financial assets.•Identify the expected return, factor betas, factors, and firm-specific components of an asset from its factor equation.•Explain how the principle of diversification relates to firm-specific risk.•Be able to compute the factor betas for a portfolio given the factor betas of its component securities.•Be able to design a portfolio with a specific configuration of factor betas in order to design portfolios that perfectly hedge an investment’s endowment of factor risk.•Make sense of the arbitrage pricing theory (APT) equation.