Complete the procedure in Appendix A for reducing a general three-index model to a three-index model with orthogonal indexes.
Answer to relevant QuestionsAssume that all assumptions of the single-index model hold, except that the covariance between residuals is a constant K instead of zero. Derive the covariance between the two securities and the variance on a portfolio. Given the multi-index model Where I*1 and I*2 are correlated, and given the regression equation I*2 = 1 + 1.3I1 + dt, transform the equation for Ri into one with orthogonal indexes. Consider the following three investments. Which are preferred if U(W) = W -(1/2)W2? If RL = 5% and α = 10%, what is the preferred investment shown in Problem 1 using Telser’s safety-first criterion? In Problem 1 What is the correlation of return between markets from the point of view of each investor?
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