Microsoft PowerPoint - PoF.ppt

Assumptionƒ 86

Security returns are not longer correlated for only one reason, i.p.

each security is assumed to respond to the

pull of two or more factors!

ƒ

t J t F F J t F F J J t J

r

r

A

r

,

, 2

2

,

, 1

1

,

,

...

ε

β

β

+

+

+

+

=

Single-period random cash flows: Factor models - MFM

...

)

,

(

2 2

2

,

2

,

2 1

1

,

1

,

́

+

+

=

⇒

F F K F J F F K F J K J

r

r

Cov

σ β β σ β β (

)

()

0

,

cov

0

2

, 1

cov

= =

K

J

and

F

F

ε

ε