Motivation 78Estimates of expected returns and covariances between the securitiesÄcompute efficient setHow can one get these estimates?Sampling from past returnsÄ(arithmetic) mean and samplecovariance- Advantage: easy and fast- Disadvantage: sample size
Äsampling errorBUT sample sizeÄprobability that series of stockreturns doesn’t reflect thecontemporary character ofthe firmSingle-period random cash flows: Factor models - Motivation