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Assume we fit an ARMA(2,0) model to the daily return on market portfolio. Model outcome is...

Assume we fit an ARMA(2,0) model to the daily return on market portfolio. Model outcome is provided below.

Rt = 0.75+0.6*Rt-1+0.3* Rt-2

Given that today is Monday and return on market portfolio is 1% today and it was 0.5% yesterday, what is your forecast for Friday?
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Answer #1

Given,

Rt = 0.75 + 0.6*Rt-1 + 0.3* Rt-2

RMonday = 1

RSunday = 0.5

=> RTuesday = 0.75 + 0.6*RMonday + 0.3* RSunday = 0.75 + 0.6*1+ 0.3*0.5 = 1.5

RWednesday = 0.75 + 0.6*RTuesday + 0.3* RMonday = 0.75 + 0.6*1.5+ 0.3*1 = 1.95

RThursday = 0.75 + 0.6*RWednesday + 0.3* RTuesday = 0.75 + 0.6*1.95+ 0.3*1.5 = 2.37

RFriday = 0.75 + 0.6*RThursday + 0.3* RWednesday = 0.75 + 0.6*2.37+ 0.3*1.95 = 2.757%

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