Answer Happy

(a) In the context of APT with two risk factors 11 and 12, consider three well-diversified portfolios whose returns are given by Ř = 0.02 + 11 - 212 Ř2 = 0.03 + 211 – 12 Řz = 0.04 + 311 + 212 == Note that, according to the convention we followed in the course, we have E[ſ] = E[ſ2] = 0.
ÑA = 0.04 +211 + 12
(b) You are implementing the Black-Litterman model in the context of managing a portfolio with four assets. The market capitalization weights for these four assets are given by w1 = 0.30, W2 = 0.2, w3 = 0.15, w4 = 0.35 = You are using a parameter 1 = 0.2, and the elements of your implied expected excess returns vector II are given by II1 = 9%, 112 = 9%, 113 = 4%, 114 = 3% = (i) [4 Marks] Describe the effect of introducing the possibility of measurement error in vector of expected excess returns in the model. With the parameters given above, what would be the investor's equilibrium weights in all assets (risky and risk-free) if this measurement error is introduced into the framework (if no views are imposed)?