Probably one of the few things I don’t really know. How important do you think it is for exam day?
judging from the online practice and mocks, pretty important, it appears in both of them
not the answer I wanted lol
It’s not really that hard to figure out. Won’t take you an hour to learn it.
Siimple way to remember it.
The basic stuff that’ll be there in both the fully integrted and the fully segmented parts are as follows:
% of integration/(1 - % of integration) x standard deviation of the asset x sharpe ratio of GIM
In the case of the fully integrated part, you have to multiply the correlation between the GIM & the asset as well since integrated market means correlated returns.
If there’s an illiquidity premium, it has to be added at the end.
so ERP = Illiquidity premium + [% of integration x s.d. of asset x correlation between asset & GIM x Sharpe of GIM] + [(1 - % of integration) x s.d. of asset x Sharpe of GIM]
hope that helps.
Needs correlation x std dev of asset x sharpe ratio market portfolio
- Weight them
Usually integrated one is given
I always wonder why the rationale that if they are fully segmented, the correlation between GIM and the security is +1 (perfectly correlated).
When it asks for the equity risk premium, I don’t think we need to add RFR
Because it assumes the market is the local segmented market which then makes sense.
The real question is why it still assumes the world Sharpe Ratio which is pretty nonsense to me
When it is 100% segmented, the GIM is the local market from the local investor’s point of view.