Investments, tenth edition

 Figure 8.1 

The variance of an equally weighted portfolio with risk coefficient 

b

  

 P 

  in the single-factor economy  

σ

2

P

n

σ

2

(e

P

)

 

5 

σ

2

(e)/ n

Diversifiable Risk

Systematic Risk

β

2

P

σ

2

M

 Reconsider the two stocks in Concept Check 2. 

Suppose we form an equally weighted portfolio 

of  A  and  B.  What will be the nonsystematic stan-

dard deviation of that portfolio? 

 CONCEPT CHECK 

8.3 

    8.3 

Estimating the Single-Index Model 

  Armed with the theoretical underpinnings of the single-index model, we now provide an 

extended example that begins with estimation of the regression equation (8.8) and contin-

ues through to the estimation of the full covariance matrix of security returns. 

 To keep the presentation manageable, we focus on only six large U.S. corporations: 

Hewlett-Packard and Dell from the information technology (IT) sector of the S&P 500, 

Target and Walmart from the retailing sector, and British Petroleum and Royal Dutch Shell 

from the energy sector. 

bod61671_ch08_256-290.indd   264

bod61671_ch08_256-290.indd   264

6/21/13   4:10 PM

6/21/13   4:10 PM

Final PDF to printer

---

  C H A P T E R  

8

 Index 

Models

265

 We work with monthly observations of rates of return for the six stocks, the S&P 500 

portfolio, and T-bills over a 5-year period (60 observations). As a first step, the excess 

returns on the seven risky assets are computed. We start with a detailed look at the prepara-

tion of the input list for Hewlett-Packard (HP), and then proceed to display the entire input 

list. Later in the chapter, we will show how these estimates can be used to construct the 

optimal risky portfolio.