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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?

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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Abhinav Sahani
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52 views1 page

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

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.

Uploaded by

Abhinav Sahani
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOC, PDF, TXT or read online on Scribd
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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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