Assume that stock market returns do follow a single-index structure. An investment fund analyzes 500 stocks in order to construct a mean-variance efficient portfolio constrained by 500 investments. They will need to calculate ________ estimates of firm-specific variances and ________ estimate/estimates for the variance of the macroeconomic factor.
A) 500; 1
B) 500; 500
C) 124,750; 1
D) 124,750; 500
E) 250,000; 500

Question

Quizplus · Accepted Answer

In a single-index model, each stock's return is related to a single macroeconomic factor, requiring the calculation of one firm-specific variance per stock (500 in this case) and only one estimate for the variance of the macroeconomic factor, as all stocks are assumed to be influenced by this single factor.

Assume That Stock Market Returns Do Follow a Single-Index Structure