Problem bank

Problem 287 of 333HardLinear AlgebraP287

Adding a second forecasting signal

  1. You forecast next-day returns rr with a signal ss that has correlation 0.3 with rr. You may add a second signal tt and use any linear combination as+btas + bt as the forecast.

    (a) Suppose tt has correlation 0.2 with rr and is uncorrelated with ss. What is the highest correlation with rr you can reach?

    (b) Now suppose tt has zero correlation with rr but correlation 0.5 with ss. Does adding tt help? If so, give the best combination and its correlation with rr.