The EMBI Investor

The EMBI Investor case is a practical application of statistical analysis in financial analysis. It uses the Capital Asset Pricing Model (CAPM) to introduce some basic aspects of statistics and finance and presents how these two aspects, the financial and the statistical, can be connected. This fosters interest in statistical tools through their use in financial analysis. The objectives of the case are: (a) to introduce the concepts of the regression line and the correlation, and (b) to illustrate these concepts through their application to a well-known financial model. Consequently, the equation used in the CAPM model serves as a tool to present the simple linear regression model as well as fundamental statistical measures, such as mean, standard deviation, correlation and the R-squared statistic. Based on the returns of bonds indexes, readers/students can familiarize themselves with the notions of expected return, volatility and risk and, in relation, statistical terms like mean and standard deviation. The beta coefficient in the CAPM equation is the financial equivalent of the slope in statistics. The variability of the returns as related to risk, both systemic and non-systemic, is also presented as a particular case of the decomposition of the actual value of the dependent variable into the sum of the predicted value and the residual. This dependency, along with the correlation and the squared correlation (R-squared statistic), are also explained. This case requires basic knowledge of Excel or an analogous open source spreadsheet application. It is assumed that calculations will be performed using standard spreadsheet functions and the data is supplied in an Excel file (embi-data.xls).