Question

Explain and describe how regression analysis and indexation have real-life implications that provide guidelines for: a) your investment style; b) Your professional career development;

Are you using Laspeyres or Paasche indexation? Why?

Answer 1

1. Regression Analysis:

Regression Analysis has many applications in the field of finance. For example, the CAPM (Capital Asset Pricing Model) model in finance can be stated as one of the fundamentals of Regression Analysis.

For example,

Please refer the CAPM equation given above...

(r_m - r_f) is the market risk premium.

So the equation can be modified as:

Expected Return = r_f + β * r_p

r_p = Market Risk Premium

If we compare this equation with the Regression equation i.e. Y = A + B * x

A is the intercept which is fixed, B is the slope and X is the variable...

In the CAPM equation also, r_f is always fixed as it is the minimum return we should definitely get as I am investing in the market. I can't accept any return that is less than that because it is the risk free rate of return. If any portfolio is providing me any return less than that, I shall never invest in that because bank's fixed deposit (a risk free rate of return) will be providing me that much return... In this regard, r_f is the intercept, Beta is the slope and r_p is the variable...

If we perform a regression analysis by taking return as the dependent variable, market premium as the independent variable, then we can get a equation which is indirectly the CAPM equation...

Laspeyres or Paasche Indexation:

The Laspeyres Price Index is a CPI (Consumer Price Index) which is generally used to analyse the changes in the prices of goods and services relative to a specified Base Period Weighting whereas the Paasche Price Index is also a CPI (Consumer Price Index) which is generally used to analyse the changes in the price and quantity of a basket of goods and services relative to a Base Year Price & Quantity. The formula for both these indexes are mentioned above...

End of the Solution...