Market model is a term used in finance to describe a linear regression model in
ID: 3156738 • Letter: M
Question
Market model is a term used in finance to describe a linear regression model in which the dependent variable is the return on a stock and the independent variable is the return on the overall market. The market model is sometimes extended to include other independent variables-for example, the return on a specific industry sector. Company A is one of the leading software companies in the world. Suppose an analyst in an investment bank is creating a market model to predict returns on Company A stock from both market and industry returns. The multiple regression model is: where y daily returns for Company A stock daily returns for the Dow Jones Industrial Average x2daily returns for the NASDAQ Computer Index Returns for the Dow Jones Industrial Average (DJIA) l indicate market returns, while those for the NASDAQ Computer Index (NCI) will indicate industry returns. The analyst estimates the parameters 0, 1, and 2 using daily returns for the period January 3, 2005, through December 30, 2005. The estimated multiple regression equation is: y0.00080.6404x1 0.6869x2 The coefficient 0.6404 in the estimated multiple regression equation is: O The estimated increase in average Company A stock return when the DJIA and NCI returns change by one unit O The estimated change in average Company A stock return for a one-unit change in NCI return, keeping the DJIA return constant O The estimated average Company A stock return when the DJIA and NCI returns are zero O The estimated change in average Company A stock return for a one-unit change in DJIA return, keeping the NCI return constant Based on his study, the analyst expects an upturn for the overall market and the computer industry. He expects a 196 0.01 return for the DJIA and a 2%-0.02 return for the NCI when the DJIA return is 196 and the NCI return is 2%, the average company A stock return for all trading days is estimated to be ,and the predicted Company A stock return for one specific trading day is This predicted return has the average return.Explanation / Answer
1)0.6404 is the estimated change in average Company A stock return for one unit change in DJIA return,keeping the NCI return constant.
2)The average return=(0.26+3.93)/2=2.095%
3)Confidence interval is 0.26% to 3.93%
Predicted Interval is -9.61% to 13.80%
4)The interval for the average stock return is narrower than that of the predicted because you can estimate average return with more precision that you can predict.
5)Portfolio value=1000*40=40000
Hence predicted value=40000*(1-0.0961) to 40000*(1+0.138) =36156 to 45520