Chap010 - CHAPTER 10 Arbitrage Pricing Arbitrage Theory and...

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Investments Bodie, Kane and Marcus CHAPTER 10 CHAPTER 10 Arbitrage Pricing Arbitrage Pricing Theory and Theory and Multifactor Multifactor Models of Risk Models of Risk and Return and Return
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10-2 Single Factor Model Returns on a security come from two sources Common macro-economic factor Firm specific events Possible common macro-economic factors Gross Domestic Product Growth Interest Rates
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10-3 Single Factor Model Equation r i = Return for security I = Factor sensitivity or factor loading or factor beta F = Surprise in macro-economic factor (F could be positive, negative or zero) e i = Firm specific events ( ) i i i i r E r F e β = + + i β
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10-4 Multifactor Models Use more than one factor in addition to market return Examples include gross domestic product, expected inflation, interest rates etc. Estimate a beta or factor loading for each factor using multiple regression.
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10-5 Multifactor Model Equation r i = E(r i ) + GDP GDP + IR IR + e i r i = Return for security i GDP
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