Variance formula

[sfad]

Asset class Global Equity sensitivity Global bonds sensitivity Residual risk
Real estate equities 0.6 0.15 4.4%
Other information
Variance 0.025 0.0014
We are calculating the variance of real estate:
0.6^2 x 0.025^2 + 0.15^2 x 0.0014 + 2 x 0.6 x 0.15 x 0.002 + 0.044
Why in the answer does the formula add the residual risk at the end (4.4%)?

 

[MrSmart]

Why are you squaring the variance? I guess that was a typo.
Residual risk can be derived by solving for the variance of the error term, if not given. But it is part of the equation.

 

[cokemicho]

+1 w/ MrSmart
You’re squaring the already squared SD.
its a variance “normal” formula but remember to add the residual risk inside the root square part and thats it.
Also I dont remember if .002 is the correlation. This is from a mock or something right? remember that question.

 

[sfad]

cokemicho wrote:
+1 w/ MrSmart
You’re squaring the already squared SD.
its a variance “normal” formula but remember to add the residual risk inside the root square part and thats it.
Also I dont remember if .002 is the correlation. This is from a mock or something right? remember that question.

1. Are the sensitivitis standard deviations?
2. If the residual risk is included, do we always add it at the end? All the other variance questions I have seen do not include residual risk, hence why i haven’t seen it before.

 

[cokemicho]

sfad wrote:

cokemicho wrote:
+1 w/ MrSmart
You’re squaring the already squared SD.
its a variance “normal” formula but remember to add the residual risk inside the root square part and thats it.
Also I dont remember if .002 is the correlation. This is from a mock or something right? remember that question.

1. Are the sensitivitis standard deviations?
2. If the residual risk is included, do we always add it at the end? All the other variance questions I have seen do not include residual risk, hence why i haven’t seen it before.

As you post Variance .025 and in the formula you put .025^2 you are squaring the variance right? Yes you do my friend. When talking about ICAPM you do. As the textbook says (CFA way)