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Lecture_06 - Single Index and Multifactor Models Professor...

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Fall 2010 Investment Management, FINE 441, Lecture 6 1 Professor Ruslan Goyenko Single Index and Multifactor Models
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Single Factor Model ri = E(ri) + mi + ei where E(ri)=i is the expected return on the security at the beginning of the holding period mi is the unexpected common macroeconomic shock to the economy m affects all stocks ei is the impact of unexpected firm specific events, or firm specific risk E[mi]=0
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Single Factor Model Taking into account that different firm have different sensitivities to macroeconomic factors ri = + ßif + ei ßi =sensitivity of a securities’ particular return to the factor f= some macro factor; in this case f is unanticipated movement; f is commonly related to security returns (can be market index – S&P500) i α
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(ri - rf) = i + ßi(rm - rf) + ei a Risk Prem Market Risk Prem or Index Risk Prem i = the stock’s expected return if the market’s excess return is zero ßi(rm - rf) = the component of return due to movements in the market index (rm - rf) = 0 ei = firm specific component, not due to market movements a Single Index Model
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