Yellow = input

1a. Foundations. Jorion: Parametric VaR

Assumptions: i.i.d., normal returns
Initial value
Initial Period (days)
Mean return (daily)
Volatility (daily)
Confidence
Normal deviate
Target horizon (days)

$100
1
0.00%
1.0%
99%
2.33
10

$100
1
0.00%
1.0%
99%
2.33
10

$100
1
0.00%
1.0%
99%
2.33
10

$100
1
0.00%
1.0%
99%
2.33
10

$100
1
0.00%
1.0%
99%
2.33
10

n-day VaR, %
n-day VaR, ($)

7.36%
$7.36

7.36%
$7.36

7.36%
$7.36

7.36%
$7.36

7.36%
$7.36

8%
4%
20%
0.04

8%
4%
30%
0.09

8%
4%
40%
0.02

8%
4%
10%
0

8%
4%
10%
-0.02

1.00
4.0%
8.0%

1.00
4.0%
8.0%

0.13
4.0%
4.5%

4.0%
4.0%

(2.00)
4.0%
-4.0%

1a. Foundations. Amenc: Portfolio RAPMs

Expected Return
10%
Volatility
20%
Correlation with Market (rho)
0.5

11%
25%
0.5

12%
30%
0.5

13%
40%
0.5

14%
45%
0.5

0.42
0.17
0.28
5.3%
27.8%
0.11

0.38
0.21
0.27
6.5%
36.1%
0.11

2.00
0.05
0.23
1.0%
36.1%
0.14

2.25
0.04
0.22
1.0%
40.9%
0.15

1a. Foundations. Amenc: CAPM

Expected Return, Market
Riskless rate
Volatility, Market
Covariance (Market, Security)
Security Beta
Excess return, market (ERP)
CAPM Exp return (security)

Portfolio Beta
Treynor
Sharpe
Jenson
Tracking Error
Information ratio

0.50
0.12
0.30
4.0%
20.0%
0.10

Parametric VaR (normal but we can use other

distributions. Parametric does not --> normal)

Historical Simulation (HS) VaR

(i.e., non-parametric)

Standard Deviation (Volatility), Daily

Confidence Level, c
Significance Level, 1-c
Target Horizon (days)
Autocorrelation
1-day Value at Risk (VaR)

1-day HS VaR:

Extended over Target Horizon (i.i.d)

Standard deviation (i.i.d)
n-day VaR (i.i.d)

1.0%
99.0%
1%
10
0.25
-2.33%

3.16%
7.36%

Extended over Target Horizon (autocorrelated)

Scaling factor
15.78
Standard deviation (with autocorr.)
3.97%
VaR over horizon (with autocorr.)
9.24%

Notes:
We have simplified by assuming mean return = 0
Autocorrelation is used to violate i.i.d.

Period

t-1
t-2
t-3
t-4
t-5
t-6
t-7
t-8
t-9
t - 10
t - 11
t - 12
t - 13
t - 14
t - 15
t - 16
t - 17
t - 18
t - 19
t - 20
t - 21
t - 22
t - 23
t - 24
t - 25
t - 26
t - 27
t - 28
t - 29
t - 30

-2.12%

Return
-0.6% << this is just a series o
0.7%
0.2%
-2.5%
0.9%
0.3%
0.6%
0.3%
0.7%
0.9%
0.7%
-1.0%
-1.2%
-0.8%
0.7%
0.1%
-1.2%
-0.9%
0.8%
-0.4%
-0.4%
1.0%
-0.3%
-0.4%
-0.5%
0.2%
1.3%
-0.1%
0.1%
-0.5%

<< this is just a series of simulated returns

A B
C
D
CAPITAL MARKET LINE (CML)
Riskless rate
7.00%
Asset A
Exp Return
Std Deviation
Variance
Asset B
Exp Return
Std Deviation
Variance
Correlation
Covariance
Market
Portfolio (M)
Asset A
Asset B
Exp return, M
Volatility, M
% in Market
Portfolio
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
125%
150%
175%
200%
225%
250%
275%
300%

10.00%
10.00%
0.0100

15.00%
20.00%
0.0400
20.00%
0.00400

Expected Return

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44

19.0%

Portfolio

17.0%

CML

15.0%

Market Portfolio

13.0%
11.0%
9.0%
7.0%
5.0%
0.0%

10.0%
20.0%
Standard Deviation

Percent
56.4%
43.6%
12.18%
11.29%

Volatility
0.0%
1.1%
2.3%
3.4%
4.5%
5.6%
6.8%
7.9%
9.0%
10.2%
11.3%
14.1%
16.9%
19.8%
22.6%
25.4%
28.2%
31.1%
33.9%

Expected
Return
(CML)
7.0%
7.5%
8.0%
8.6%
9.1%
9.6%
10.1%
10.6%
11.1%
11.7%
12.2%
13.5%
14.8%
16.1%
17.4%
18.7%
19.9%
21.2%
22.5%

Step:

K
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44

% in
Asset A
56.4%

L
Standard
Deviation
11.3%

M
Expected
Return
12.2%

N
Sharpe
Ratio
0.46

% in
Asset A
-50%
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
56%
66%
76%
86%
96%
106%
116%
126%
136%
146%
156%
166%

Standard
Deviation
29.4%
27.5%
25.6%
23.7%
21.8%
20.0%
18.2%
16.5%
14.9%
13.4%
11.3%
10.3%
9.8%
9.6%
9.8%
10.5%
11.4%
12.7%
14.1%
15.7%
17.4%
19.1%

Expected
Return
17.5%
17.0%
16.5%
16.0%
15.5%
15.0%
14.5%
14.0%
13.5%
13.0%
12.2%
11.7%
11.2%
10.7%
10.2%
9.7%
9.2%
8.7%
8.2%
7.7%
7.2%
6.7%

Sharpe
Ratio
0.36
0.36
0.37
0.38
0.39
0.40
0.41
0.42
0.44
0.45
0.46
0.45
0.43
0.38
0.32
0.26
0.19
0.13
0.08
0.04
0.01
(0.02)

10%

SP

E(RP ) RF
(RP )

The market portfolio

maximizes the Sharpe ratio!

T
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44

V
Standard
Deviation
29.4%
27.5%
25.6%
23.7%
21.8%
20.0%
18.2%
16.5%
14.9%
13.4%
11.3%
10.3%
9.8%
9.6%
9.8%
10.5%
11.4%
12.7%
14.1%
15.7%
17.4%
19.1%

W
Expected
Return
17.5%
17.0%
16.5%
16.0%
15.5%
15.0%
14.5%
14.0%
13.5%
13.0%
12.2%
11.7%
11.2%
10.7%
10.2%
9.7%
9.2%
8.7%
8.2%
7.7%
7.2%
6.7%

X
Sharpe
Ratio
0.36
0.36
0.37
0.38
0.39
0.40
0.41
0.42
0.44
0.45
0.46
0.45

A B
C
D
SECURITY MARKET LINE (SML)
Riskless rate
7.00%
Asset A
Exp Return
10.00%
Std Deviation
10.00%
Variance
0.0100
Asset B
Exp Return
Std Deviation
Variance
Correlation
Covariance
Market Portfolio (M)
Asset A
Asset B
Exp return, M
Volatility, M
Market excess return

15.00%
20.00%
0.0400

(0.000)
(0.000)
7.0%
7.0%

15%
10%
5%
0%
0.00

1.00

2.00

3.00

Beta

E(Ri ) RF i[E(RM ) RF )]
E( Ri ) RF

Selected Portfolios (Note they are all on the SML)

Asset A
160%
100%
Asset B
-60%
0%
Covariance (Port, Market)
Beta
Expected Return
Expected return

20%

20.00%
0.00400
Percent
56.41%
43.59%
12.18%
11.29%
5.18%

25%
Expected Return

1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31

0.007
0.579
10.0%
10.0%

cov(Ri , Rm )
cov
[ E( RM ) RF )] E( Ri ) RF
var( Rm )
v

50%
50%

56%
44%

0%
100%

-50%
150%

-100%
200%

0.014
1.062
12.5%
12.5%

0.013
1.000
12.2%
12.2%

0.020
1.545
15.0%
15.0%

0.026
2.027
17.5%
17.5%

0.032
2.510
20.0%
20.0%

L
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
E( R21
i)
22
23
24
25
26
27
28
29
30
31

RF

cov( Ri , Rm )
[ E( RM ) RF )]
var( Rm )

A B
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33

Security Market Line (SML) and CAPM

Risk-free rate

Average return
Standard deviation (sigma) of return
Variance (sigma ^ 2)
Correlation
Covariance of returns

2.00%
Stock A
8.00%
10.00%
0.0100
0.2000
0.0040

Stock B
14.00%
20.00%
0.0400

Market portfolio M: maximizes the Sharpe ratio

Proportion of stock A
Proportion of stock B

Please note: if you change inputs, you have to re-run solver!

66.67% << Solver only, please
33.33%

Expected market portfolio return, E(rM)

Market portfolio: return variance
Market portfolio: standard deviation

10.00%
0.0107
10.33%

Market excess return over risk-free rate

Market portfolio maximizes Sharpe ratio:

Portfolio consisting of:

% in Asset A
% in Asset B
Expected Portfolio Return, weighted
Using Security Market Line:
Cov (portfolio, market)
Beta (portfolio with respect to market)
CAPM (SML): Expected return = riskless rate + (beta)*(ERP)

8.00%
0.77 << Need to Max D21 by Changing Cell D13

Only
Asset A
100.00%
0.00%
8.00%

Only
Asset B
0.00%
100.00%
14.00%

Mix
50.00%
50.00%
11.00%

Match
Market
Portfolio!
66.67%
33.33%
10.00%

0.0080
0.7500
8.00%

0.0160
1.5000
14.00%

0.0120
1.1250
11.00%

0.0107
1.0000
10.00%

A
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36

To the right is a security market line (SML); it uses a two-asset porfolio to generate the SML. The Market Portfolio opt
Please don't change inputs under SML unless you realize you need to re-solve for the weights of Assets A & B in the op
Riskless rate
Exp Return: Market Portfolio
Excess Market Return (ERP)
Porfolio
Exp Return
Volatility (Std Dev)
Beta
Tracking Error
Years of observations (T)

7.00%
12.18%
5.18%

16%
20%
1.5
3.0%
5

SECURITY MARKET LINE

The market portfolio, M

Asset A
Asset B

56.41%
43.59%

Std Dev, Market Portfolio

11.29%

Sharpe ratio, Market

PERFORMANCE MEASURES
Treynor
Sharpe
Jensen alpha
Information ratio (IR)
t statistic

0.060
0.450
0.012
0.410
0.917

0.46

Asset A
Exp Return
Std Deviation
Variance

10.00%
10.00%
0.0100

Asset B
Exp Return
Std Deviation
Variance

15.00%
20.00%
0.0400

Correlation
Covariance

20.00%
0.00400

Selected Portfolios (Note they are all on the SML)

Asset A
167%
100%
Asset B
-67%
0%
Covariance (Port, Market)
Beta
Expected Return (beta)
Expected return (checking)

(0.0008)
(0.064)
6.7%
6.7%

0.0074
0.579
10.0%
10.0%

te the SML. The

1 Market Portfolio optimizes the Sharpe Ratio
the weights of2Assets A & B in the optimal market porfolio (i.e., maximize G13 by changing G7)

SML (CAPM)

25.0%
Expected Return

3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36

20.0%
15.0%
10.0%
5.0%

0.0%
(1.000)

1.000
Beta

50%
50%

0%
100%

-50%
150%

-100%
200%

0.0135
1.062
12.5%
12.5%

0.0197
1.545
15.0%
15.0%

0.0258
2.027
17.5%
17.5%

0.0320
2.510
20.0%
20.0%

2.000

3.000

Grinold Table 7.1 and 7.2

This APT is simply a sum of products, where the product = [factor forecast]*[exposure or Factor loading]
The exposures are standardized: they have mean of zero and unit standard deviation.
What does this mean? That an average stock will have a factor exposure of zero.
Also, a stock is primarily exposed to its industry (we can think of this as another factor!)
So, AT&T (for example) has an expected return of 6% due to its industry plus the SUMPRODUCT of its factor
Also, a stock is primarily exposed to its industry (we can think of this as another factor!)
Finally, note the CAPM is essentially a single factor model: beta * [equity risk premium = market risk factor]
Factor Forecasts

Stock
Amex
AT&T
Chevron
Coca-Cola
Disney
Dow

Industry
FinServices
Telephones
Energy
Food
Entertain
Chemical

Forecast
6.0%
6.0%
6.0%
6.0%
6.0%
8.0%

2% 2.50% -1.50% 0.00%

Standardized Exposures
(Factor Loadings or Factor Betas)
Growth
Bond
Size
ROE
0.17
-0.05
0.19
-0.28
-0.16
0.74
1.47
-0.59
-0.53
-0.24
0.83
-0.72
-0.02
0.3
1.41
1.48
0.13
-0.86
0.71
0.42
-0.64
-0.92
0.48
0.22

6.00%

Beta
1.16
0.84
0.7
1.06
1.13
1.13

APT
5.93%
5.33%
3.10%
4.60%
3.05%
3.70%

CAPM
6.96%
5.04%
4.20%
6.36%
6.78%
6.78%

f n E {rn } X n,k mk
k 1

MPRODUCT of its factors (factor forecast * factor exposure)

t risk factor]

n,k

APTCAPM
-1.03%
0.29%
-1.11%
-1.77%
-3.74%
-3.08%

mk