The following model describes the returns in a market: r = 10 + BS&P +...

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The following model describes the returns in a market: r₁ = 10 + λ₁ BS&P + 1₂PSMB + Ei where S&P refers to the broad market index and SMB refers to the small company risk factor. a) Explain both the economic and statistical properties of the PSMB parameter, making sure your answers are framed in the context of the complete asset- pricing equation. Continuing with the same model, you are told that assets A, B and C are in Arbitrage Pricing Theory equilibrium, but that asset D is mispriced. Each asset's factor exposures and expected returns are as follows: Asset ABCD BS&P 0.5 1.8 0.6 1.0 PSMB 1.0 1.3 1.6 1.3 Expected Return (%) 10.0 24.2 13.4 20.0 b) Using the information in the table, find the asset-pricing equation. c) Is asset D cheap or expensive? Explain your answer. d) Find the weights WA, WB, WC and wo of the arbitrage strategy that exploits the mispricing of asset D. The following model describes the returns in a market: r₁ = 10 + λ₁ BS&P + 1₂PSMB + Ei where S&P refers to the broad market index and SMB refers to the small company risk factor. a) Explain both the economic and statistical properties of the PSMB parameter, making sure your answers are framed in the context of the complete asset- pricing equation. Continuing with the same model, you are told that assets A, B and C are in Arbitrage Pricing Theory equilibrium, but that asset D is mispriced. Each asset's factor exposures and expected returns are as follows: Asset ABCD BS&P 0.5 1.8 0.6 1.0 PSMB 1.0 1.3 1.6 1.3 Expected Return (%) 10.0 24.2 13.4 20.0 b) Using the information in the table, find the asset-pricing equation. c) Is asset D cheap or expensive? Explain your answer. d) Find the weights WA, WB, WC and wo of the arbitrage strategy that exploits the mispricing of asset D.

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ANSWER a The parameter SMB represents the sensitivity of an assets returns to the small company risk factor SMB which is a component of the FamaFrench threefactor model In the context of the complete ... View the full answer