Single Index Model

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The Single Index Model (SIM) is an asset pricing model commonly used in the finance industry to measure risk and return of a stock. Mathematically the SIM is expressed as:

(rit − rf) = ai + Bi(rmt − rf) + Eit

Where:

• rit − rf is the return on the stock
• ai is the company's alpha
• Bi is the company's beta
• rmt − rf is the return on the market index
• Eit is the residual return

The accuracy of the model is enhanced by the stock return's influence by market (beta) and firm-specific risk factors (alpha), unexpected returns (residual) and the relation to the performance of a market index (such as the All Ordinaries). Security analysts often use the SIM for such functions as computing stock betas, evaluating stock selection skills, and conducting event studies.

[edit] References

Yip, Henry 2005: Spreadsheet Applications to securities valuation and investment theories, John Wiley and Sons Australia Ltd