Microsoft PowerPoint - PoF.ppt

Assumptions ƒ 90

Securities’ returns can be described through an index or factor model

The implicit assumption that the co

variance between factors is equal

to zero is not a necessary assumption.

ƒ

Large amounts of securities

(many more securities than

number of factors)

and the possibility of short-selling

Single-period random cash flows: Factor models - APT

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

r

r

A

r

,

, 2

2

,

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1

,

,

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ε

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2

1

2

2

,

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J

J

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N J

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F F P F F P P

x

and

i

all

for

x

where

ε

ε

ε

σ

σ

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σ σ β σ β σ

∑

∑

=

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+

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