Microsoft PowerPoint - PoF.ppt

Expected return and risk relationshipƒ 91

Given these assumptions we “derive” the approximate relationship between expected return and risk under the APT

ƒ

Suppose a single factor can explain all the covariance that exist between stocks, i.e.

single-factor APT

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What will the relationship between

E(r

)J

and

β

J,F1

look like?

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Suppose it looks as follows:

Single-period random cash flows: Factor models - APT