The variance of returns for a risky asset is 25%. The variance of the error term,...
The variance of returns for a risky asset is 25%. The variance
of the error term, Var(e), is 8%. What portion of the total risk of
the asset, as measured by variance, is systematic?
Hint: (total risk)^2 = (systematic risk)^2 + (specific risk)^2
--> σ^2 = (Bσm)^2 + (σe)^2
Homework Answers
Solution:
Given details in problem:
- The variance of returns for a risky asset is 25%.
- The variance of the error term, Var(e), is 8% as measured by variance.
Here, we need to understand what portion of the total risk of the asset systematic.
Therefore,
Var(e) / variance of returns for a risky asset
0.08/0.25 = 0.32
So, 1-0.32 = 0.68 is the portion of the total risk of the asset, as measured by variance, is systematic.
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