Skip to content

FRM Part II · FRM Exam Part II · Portfolio Construction

Equilibrium excess returns are 4% for Asset X and 6% for Asset Y. A simplified Bayesian update blends a prior mean of 6% for Asset Y (prior variance 0.0004) with a single view of 10% for Asset Y (view variance 0.0004). What is the posterior expected excess return for Asset Y?

The posterior expected return is 8%. With equal prior and view variances the precisions are identical, so the Bayesian update is a simple 50/50 average of the 6% prior and the 10% view. Ignoring either source would give 6% or 10%.

  1. A6%
  2. B8%Correct
  3. C10%
  4. D7%

Explanation

Posterior mean is the precision-weighted average. Precisions are 1/0.0004 for both, so the weights are equal: 0.5*6% + 0.5*10% = 8%. Choosing 6% ignores the view and 10% ignores the prior.

Did you get it right without looking?

One question tells you little. A timed set on Portfolio Construction shows your real accuracy, how long you take and where you lose marks.

Practise Portfolio ConstructionFree diagnostic mock

More Portfolio Construction questions