Chap008 - Investments Bodie, Kane and Marcus CHAPTER 8...

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Unformatted text preview: Investments Bodie, Kane and Marcus CHAPTER 8 CHAPTER 8 Index Models Index Models 8-2 • Reduces the number of inputs for diversification • Easier for security analysts to specialize Advantages of the Single Index Model 8-3 ß i = index of a securities’ particular return to the factor m = Unanticipated movement related to security returns e i = Assumption: a broad market index like the S&P 500 is the common factor. Single Factor Model ( ) i i i i r E r m e β = + + 8-4 Single-Index Model • Regression Equation: • Expected return-beta relationship: ( ) ( ) ( ) t i t M i R t R t e t α β = + + ( ) ( ) i i i M E R E R α β = + 8-5 Single-Index Model Continued • Risk and covariance: – Total risk = Systematic risk + Firm-specific risk: – Covariance = product of betas x market index risk: – Correlation = product of correlations with the market index 2 2 2 2 ( ) i i M i e σ β σ σ = + 2 ( , ) i j i j M Cov r r β β σ = 2 2 2 ( , ) ( , ) ( , ) i j M i M j M i j i M j M i j...
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This note was uploaded on 04/19/2011 for the course FINA 513 taught by Professor Chan during the Spring '11 term at Atlantic PR.

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Chap008 - Investments Bodie, Kane and Marcus CHAPTER 8...

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