Assume an economy where the stochastic discount factor is driven by two sources of aggregate risk....

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Assume an economy where the stochastic discount factor is driven by two sources of aggregate risk. It is the case that these two sources of risk can be captured by two factors, fi and f, that are excess returns. The stochastic discount factor is a linear function of these two excess returns. a) Derive the implied expected return-beta representation. [15 Points] b) What is a good estimate for the price of risk for each risk factor? [5 Points] Assume an economy where the stochastic discount factor is driven by two sources of aggregate risk. It is the case that these two sources of risk can be captured by two factors, fi and f, that are excess returns. The stochastic discount factor is a linear function of these two excess returns. a) Derive the implied expected return-beta representation. [15 Points] b) What is a good estimate for the price of risk for each risk factor? [5 Points]

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a To derive the implied expected returnbeta representation we start with the stochastic discount fac... View the full answer