Suppose that you are converting a well-diversified portfolio (Portfolio P) into an arbitrage portfolio. The...
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Suppose that you are converting a well-diversified portfolio (Portfolio P) into an arbitrage portfolio. The excess returns of Portfolio P can be explained by two factor APT model (i.e., = + ( ) +
( ) + , where < 0 ( ) = 0, represent the two factors and the excess returns of Benchmark 1 and Benchmark 2). In this economy, there is a risk-free asset, the rate of which is zero. Suppose = 3%, ( ) = 1.2, ( ) = 0.8. To construct the arbitrage portfolio by using
Portfolio P, do you need to sell or buy the portfolio? Show your arbitrage portfolio (i.e., you need to provide the weights of required assets). For this question, assume that your amount of buying or selling Portfolio P is one unit. What is your arbitrage profits (in percentage)?
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