Chapter 8 Models and Data 1 (A simple portfolio) Fp = 05+ fA 0.00033725 16.7%. 8 © 15 20 This yields Ay = .02 and Az = .01. 90.28 50.88 79.00 40.18 (a) The beta of the portfolio is a weighted combination of the individual betas: B=02x11+05x08+03x1=.92. Hence, applying the CAPM to the portfolio we find 92(.12 ~.05) = 11.44%. (b) Using the single-factor model, we have c = Yweo = 0.2? x 0,007? + 0.52 x 0.023? + 0.3? x.017 o? = bof +03 = 0.42? x 0.18? + 0.00033725 = 0.2776 2. (APT Factors) By the APT we have Ap = 3. (Principal components) The estimated covariance matrix of the four stocks is ‘The largest eigenvalue is 311.16 with corresponding eigenvector v= (0.217, = 10% and 10+ 2A +2 (10-4 3A1 +402 30.88 79.00 40.18 107.2 105.4 30.98 105.4 162.2 56.54 30.98 56.54 68.27 0.263, 0.360, 0.153] 35,a 36 CHAPTER 8, MODELS AND DATA which has been normalized so that the components sum (0 One. ‘Therefore, the ‘arst principal component is 0.21773 + 0.263r2 + 0.360r3 + 0.1537-. This can be ars Pyered as the weighted average of the returns of the four stocks, and resem: bles the return of the market portfolio. “The top part of Table 82 is reproduced here, showing the time ‘values of the principle component. Note that its behavior is similar to that of the market. Principal Year stock! stock? _stock’3_stock 4 _market_disiless aT 27.04 23. 19.37 15.25 17.05 17.54 6.70 2 3 364 3.53 10.20 2.70 6.40 4 24.37 17.67 20.26 19.34 5.70 5 30.42 12.74 19.84 19.81 5.90 6 145 2.56 {ist -439 5.20 7 20.11 25.46 12.24 18.90 4.90 8 9.28 6.92 16.12 12.78 5.50 9 17.63 9.73 22:93 13.34 6.10 18 E51 25109 16.94 3.49 15.31 5.80 _16.76 wer 15. 3015. “Bs var 90.28 107.24 162.19 68.27 72.12 84.93 4, (Variance estimate) EG?) Sen-re| “(es i (n-4 z “) | E(m-n -1E0-n) | als (a -2yin-7) 2D -n) | i i 5, (Are more data helpful?) fa) ey ant OF) = o(nn) = me o van Hence o (#) is independent of nm. ) As Part (a the est does 6. (Artec @ ) © @ ASEAo) Assuming normality, (82) = o(ngd) = nek sa CHAPTER 8. MODEISANDDATA 37 ot Eo, Mot Ya-in ~ ya-1 art (a) shows that by using smaller periods to get more samples does not improve the estimate of 7. Part (b) shows that using smaller periods to get more samples does improve the estimate of o?, 6. (Arecord) Assuming a normal population, @ ©) © om On oFm) op) oom) o(?yn) ¥ 1} im = naw ni Fy = 12% m = 12%. 12 sD i- Fm)? = 0.00072 ale VI26m = 9.29% O(12Fm) = 120m = 6.6% v2e%, _ 2x 72 ra 1 (126m) = 120-(Giq) = 0.0025. 9.00021 (d) From the previous exercise we know that the estimate of F will not be im- proved by having weekly, rather than monthly samples. All that matters is ‘the total length of the period that is observed. However, the estimate in o? can be improved. In fact, letting o”***(6%,) denote the standard devia~ tion in 62, based on weekly data, we expect that o****(3%) = igo (8%) = A762, = 0012. 7. (Clever, but no cigar) First divide the year into half-month intervals and index these time points by i. Let 7; be the retum over the i-th full month (but some will start midway through the month). We let F and 0 denote the monthly expected return and variance of that return.38 CHAPTER &. MODELS AND DATA Now let py be the return over the ith half-month period. Assume that these novrrns are uncorrelated. Then Pi = Fm/2 and o2(p4) = 0/2. The retuen OO Sip monthly period isa sum of two half'month returas; thats themonthly S00) ris ri = Pi + Pist» It is easy to see that cov(ri,7isa) = $0? and coviri,7s) = 0 for |i jl>1- ‘Now for Gavin's scheme we form the estimate 1a Kon ‘We need to evaluate es 2 1 oh) = ag [Ee A | u S. covirus) ijel aE 2 2 - = F leov(ri-a.rd) + cov(rinr) + cov(ris tiv] a Except at the two end periods, each i will give three terms as show”, We will Tabet alight discrepancy tthe ends and assume that every gives tbe OS terms as shown in the summation. The terms are 30, 0%, and 402, respectively. Hence we have a ae 2 = 5" which i identical to the result for twelve nonoverlapping months of data, 8, (General tilting) (@ LetP = PT = 1,0 = 02, and Q = 1/0, Then Pep. 1 oF 0 [i] [4 a) Then P'O"!P = of + 6}, and P7Q"'P = By + Bp. Hence (Bara) - or) = x24(3 +14 5)? () Let Chap Gen cu 2. fo