Question: How to construct a typical zero investment arbitrage portfolio as a hedge fund manager if you have the following assets: Asset p which has an

How to construct a typical zero investment arbitrage portfolio as a hedge fund manager if you have the following assets: Asset p which has an excess return of R_p,t that follows the following process: R_p,t=alpha_p+beta_p*R_m,tte_p,t, where e_p,t is idiosyncratic risk of the asset that on average will be zero over time. A risk-free asset which has a return of 0. The market portfolio has a return of R_m,t As a hedge fund manager, your purpose is to deliver alpha_p on average. Notations: Denote the weights you put on asset p, risk-free asset, and the market portfolio, wp, wf, and wm, respectively. Assume that you need zero collateral for short selling. wp=1 O wm=-1 wf=-beta_p wp=0.5 O wm=-0.5*beta_p wf=0.5*beta_p-0.5 wp= 1 wm=0 O wf=0 wp=1 wm=-beta_p O wf=beta_p-1

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