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Ivestment Management - Week 6 - MULTI-FACTOR MODEL
Ivestment Management - Week 6 - MULTI-FACTOR MODEL
For any given level of risk we can construct an infinite number of portfolios, but only one
will be efficient. It is impossible to generate returns beyond the efficient frontier under
this theory.
E(R ) = R + Beta[E(R ) - R ]
i f m f
Where :
E(R )i = Expected return of asset i
Rf = Risk free rate of return
E(R )m = Expected return of the market
[E(R ) - R ]
m f = (equity) market risk premium
Beta : .5
R = 7.5%
m
Jensen’s alpha
Ex :
1. How much Jensen’s alpha did this manager generate when
R = 9.5% ; R = 2.3% ; R - R = 6.25% ; beta = 1.02
p f m f
Where :
HmL = high BTM minus low BTM (the value premium)
SmB = Small caps less Big caps (the small cap premium or size premium)
H = exposure to HmL
S = exposure to SmB
B=1… always
Alpha =< 0
All that matters is exposure to the value and small caps premia.
Ex :
1. What return do you expect to achieve from a portfolio with an exposure to the value
premium (3.45%) of 37.5%, exposure to the small cap premium (1.83%) 65.4%, a risk
free rate of 2.74% and an equity risk premium of 6.35%?
Ans:
R = 2.74 + 1 x 6.35% + .375 x 3.45 + .654 x 1.83 = 11.58%
p
2. HmL = (4.7%) of -22.99%, SmB = (3.22%) of -25.67%, R = 3.99%, equity risk premium =
f
Where :
UmD = the momentum effect
U = exposure to the momentum effect
Alpha = Carhart’s alpha
Ex :
Find Carhart’s alpha where
R = 9.81% ; R = 4.75% ; equity risk premium = 7.85%
p f