Week 4_Single Index Model

Week 4_Single Index Model - Risk and Return Single Index...

Info iconThis preview shows pages 1–11. Sign up to view the full content.

View Full Document Right Arrow Icon
Risk and Return Single Index and Multi-factor Models
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
2 Last Time ± Introduced the CAPM ² Limits to diversification ² Certain types of risk are priced ² Role of the market portfolio ² Expected return on an asset is related to its risk relative to a very well-diversified portfolio ² What is the market portfolio? ± www.moneychimp.com/articles/valuation/ capm.htm ² For MSFT
Background image of page 2
3 Expected Return and Risk ± The CAPM says the market portfolio is the tangency portfolio: ² Expected return = Risk-free rate + (Reward to per unit of market risk) × (Amount of market risk) ² Expected return = Price of time + (Price of market risk) × (Amount of market risk) ± The CAPM equation: −− =⇒ =+ σ σ if Mf 2 iM i M 2 M M E(r ) r E( cov(r, r) r cov(r r ,r ) ) −= β β = σ ifi i 2 M Cov(r,r ) [E(r ) r ] where
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
4 β as a Measure of Risk ± β is a measure of stock i’s market risk: ² The contribution of stock i to total market risk σ M . ² The co-movement between stock i and the market portfolio. ² The characteristic line: R i,t = α i + β i R M,t + e i,t R M R i The characteristic line * * * * * * * * * * * α i β i
Background image of page 4
5 SML for Stock Selection E(r A ) β M r f E(r M ) 1 E(r) SML α A β A A E(r A ) - r f = α A + [E(r M ) - r f ] β A
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
6 Text reference ± This week lecture: Chapter 8 ² Tutorial problems due this week: ± Ch9: 1-17, CFA: 1-12 ± Next week lecture: Chapter 10 ² Tutorial problems due next week: ± Ch8: 1-17, CFA: 1-5
Background image of page 6
7 Today ± Index models ± The Single Index Model ² Risk decomposition ² Covariance ± Multi-index models ± Risk factors
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
8 Single Factor Model ± Start with expected FIRM SPECIFIC changes for the variable ± Assume a single indicator (factor) accounts for all unexpected changes common to different variables ± Assume all other unexpected changes are variable specific ± Determine/estimate the sensitivity of the variable to the indicator ² for example, if the variable is returns on a security: r i =E ( r i ) + m i + ε i β i
Background image of page 8
9 Single Index Model ± Specific single factor model ± The factor is an observable market index ± All return not captured by the factor is attributable to firm specific events r i -r f = α i + β i (r M f ) + e i
Background image of page 9

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
10 The Single-Index Model ± The firm-specific effects are given by α i +e i with α i being a constant and e i
Background image of page 10
Image of page 11
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 05/02/2010 for the course ACCT 3756 taught by Professor Leung during the Three '09 term at University of Sydney.

Page1 / 31

Week 4_Single Index Model - Risk and Return Single Index...

This preview shows document pages 1 - 11. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online