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Econ 333 Spring 081Factor Models and the Arbitrage Pricing Theory
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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.