PM: Market Model specific, across, always, 2011

meghanjackson

Reference: 2011 Schweser Portfolio Management, pg. 203 #14.


One of the assumptions of the Market Model is that firm specific events are uncorrelated across assets.

If the above is true then the Cov will always be zero - using the covariance formula for Market Model we have:

Cov for asset i and j = Beta i * Beta j* Variance for market
= Beta i * Beta j * (Correlation for i and j * std dev i * std dev j) / Beta i

So, if we subtitute zero for 'Correlation for i and j' above then the 'Cov for asset i and j' is zero.

Am I missing something?