Regression

[desh]

Q. Consider Stock A & B. Assume their Annual returns are jointly normally distributed. the marginal distribution of each stock has mean of 2% and standard deviation of 10% and Correlation of 0.9%. What is expected annual return of stock A if the annual return of Stock B is 3%

Ans: Regression Model of A on B is RA = 2%+0.9(10%/10%)(RB-2%)+error term
which is RA =2.90% for RB=3% ,

How the above model is constructed ???

 

[desh]

Eureka ... I Got It....

Beta = Cov(x,y)/Var(x) , Correlation = Cov(x,y)/Var(x)Var(y) =beta/var(y) , therefore Beta = Correlation * Var (y) = correlation* (Y- mean of Y)

Return on A given return of B =3%, = Mean Return + Correlation* (RB-2%) +e(e=0) , RA =2.90%

Is it correct.........???

 

[Nicole Seaman]

Hello @desh

It is very helpful if you do a search in the forum before posting a new thread because you may find that your question has already been answered. A quick search of the first few words of the question brought up these threads where this specific question has already been discussed in detail. It may help to confirm that your understanding above is correct

1. https://forum.bionicturtle.com/posts/10464/
   
2. https://forum.bionicturtle.com/posts/3951/
   
3. https://forum.bionicturtle.com/posts/6590/

Hope this helps!

Nicole