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 ________ 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

Since the fund is assuming a single-index structure for stock returns, they only need to estimate firm-specific variances (one estimate for each stock) and one estimate for the variance of the macroeconomic factor (the index). Therefore, they will need 500 estimates of firm-specific variances and only one estimate for the index variance, for a total of 500 estimates. This matches answer choice A.

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