Suppose that the simple return of a stock follows the model rt = 0.1 + at − 0.5at−2, where at (from t=1 to T) follows a white noise process with mean zero and variance 0.04. Please compute the following: (a). What is the mean of rt? (b). What is the variance of rt? (c). Compute the first order autocorrelation of rt. (d). Compute the second order autocorrelation of rt. (e). Assume that you are standing at period 100 and a100 = 0.01. Compute the 2-step-ahead forecast of the return.
