Single Index and Multiple

Index Model
Single Index Model
• The single-index model (SIM) is a simple asset pricing model to
measure both the risk and the return of a stock.
• The Single Index Model (SIM) is an asset pricing model, according to
which the returns on a security can be represented as a linear
relationship with any economic variable relevant to the security.
• In case of stocks, this single factor is the market return.
• The SIM for stock returns can be represented as follows:
• Mathematically the SIM is expressed as:

• Alpha (α) represents the abnormal returns for the stock

• β(rm − rf) represents the movement of the market modified by the
stock’s beta
• ε represents the unsystematic risk of the security due to firm-specific
factors.
Multiple Index Model
• A multi-factor model is a financial model that employs multiple
factors in its calculations to explain market phenomena and/or
equilibrium asset prices. The multi-factor model can be used to
explain either an individual security or a portfolio of securities.
• It does so by comparing two or more factors to analyze relationships
between variables and the resulting performance.
• The formula for calculating is:
Ri = ai + _i(m) * Rm + _i(1) * F1 + _i(2) * F2 +...+_i(N) * FN + ei
where,
• Ri is the return of security i
• Rm is the market return
• F(1, 2, 3 ... N) is each of the factors used
• _ is the beta with respect to each factor including the market (m)
• e is the error term
• a is the intercept