9 Index Models and The Arbitrage Pricing Theory

9 Index Models and The Arbitrage Pricing Theory - Index...

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Comm367 1 Index Models and the Arbitrage Pricing Theory Objectives To introduce the index model and the APT To discuss & illustrate arbitrage The Single Index Model The Arbitrage Pricing Theory
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Comm367 2 Advantages : Reduces the number of inputs for diversification Easier for security analysts to specialize Drawback : simple dichotomy rules out important risk sources (such as industry events) The Single Index Model
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Comm367 3 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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Comm367 4 ßi = index of a security’s particular return to the factor F= some macro factor; in this case F is unanticipated movement; F is commonly related to security returns Single Factor Model i i i i e F ) R ( E r + β + = Assumption: a broad market index like  the S&P/TSX Composite is the common factor
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Comm367 5 Single Index Model i f M i i f i e ) r r ( ) r r ( + - β + α = - α i = stock’s expected return if market’s excess return is zero 
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This note was uploaded on 08/03/2011 for the course ECON 503 taught by Professor Motherfucker during the Spring '11 term at Aarhus Universitet.

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9 Index Models and The Arbitrage Pricing Theory - Index...

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