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  • Single Index Model: What Is The Expression For This? What Is The Expression For This? What Is The Expression For This?

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    Abhinav Sahani
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    The document describes the single-index model, which represents the relationship between a stock's return and the market's performance. It defines key terms in the model's equations: the stock's expected return independent of the market (αi), the market's expected return (Rm), and the stock's sensitivity to market movements (βi). It also notes that the model assumes the random error term (ei) has an expected mean of zero, securities are only related through their common response to the market, and lists the variances of ei and Rm.

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    The document describes the single-index model, which represents the relationship between a stock's return and the market's performance. It defines key terms in the model's equations: the stock's expected return independent of the market (αi), the market's expected return (Rm), and the stock's sensitivity to market movements (βi). It also notes that the model assumes the random error term (ei) has an expected mean of zero, securities are only related through their common response to the market, and lists the variances of ei and Rm.

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    © All Rights Reserved
    Download as DOC, PDF, TXT or read online from Scribd
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    6 views1 page

    Single Index Model: What Is The Expression For This? What Is The Expression For This? What Is The Expression For This?

    Uploaded by

    Abhinav Sahani
    The document describes the single-index model, which represents the relationship between a stock's return and the market's performance. It defines key terms in the model's equations: the stock's expected return independent of the market (αi), the market's expected return (Rm), and the stock's sensitivity to market movements (βi). It also notes that the model assumes the random error term (ei) has an expected mean of zero, securities are only related through their common response to the market, and lists the variances of ei and Rm.

    Copyright:

    © All Rights Reserved
    Download as DOC, PDF, TXT or read online from Scribd
    Flag for inappropriate content
    of 1

    SINGLE INDEX MODEL

    Consider the equation for return on a stock.

    Ri = ai + βi Rm ---------------- Eqn. (1)

    ai is the component of stock i’s return that is independent of the market’s performance – a
    random variable

    Further,
    Ri = αi + βi Rm + ei ------------ Eqn. (2)

    αi is the expected value of the component of the stock’s return that is independent of the
    market’s performance

    Rm is the rate of return on the market index – a random variable

    βi is a constant that measures the expected change in Ri given a change in Rm

    ei represents the random element of ai

     Eqn. (1) is the basic equation of the single-index model


     Mean of ei is zero – what is the expression for this?
     Index is unrelated to unique return – what is the expression for this?
     Securities are only related through common response to market – what is the
    expression for this?
     Variance of ei is denoted as σ2ei
     Variance of Rm is σ2m

    Derive the expected return, standard deviation, and covariance when the single-
    index model is used to represent the joint movement of securities.

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