The CER model

A quick recap on the constant expected return model (CER) as seen in the previous chapter:

$$R_{it} = \mu_i + \epsilon_{it} \text{, with } t = 1,\ldots,T$$ $$\epsilon_{it} \sim \text{ iid } N(0,\sigma_i ^ 2)$$ $$cov(\epsilon_{it},\epsilon_{jt}) = \sigma_{ij}$$

where $R_{it}$ denotes the continuously compounded return on asset $i$, now with $i = $ Microsoft and Boeing.

As discussed in the previous chapter, the parameters $\mu_i$, $\sigma_i$ and $\rho_{ij}$ are unknown to us. However, you can estimate the model parameters for both the Boeing and the Microsoft stock based on the data in returns_df.

Assign to sigma2_annual the estimates of $\sigma_i ^ 2$ for both assets (i.e. $i = $ Boeing and Microsoft respectively). Calculate the corresponding $\hat{\sigma}_i$ as well and assign it to sigma_annual.
The annual CER model parameters for Boeing are provided. Calculate those for Microsoft as well.
Estimate the correlations $\rho_{ij}$ between both stocks and assign the result to rho_boeing_msft.

Exercise

The CER model

Instructions