Explanation: The solution states: "The EWMA formula is: σₙ² = (1 − λ)rₙ₋₁² + λσₙ₋₁²"

EWMA Formula Components:

• σₙ² = current variance estimate
• rₙ₋₁² = squared return from previous period
• σₙ₋₁² = previous variance estimate
• λ = decay factor (0 < λ < 1)

Key Points:

• The weight (1 - λ) is applied to the most recent squared return
• The weight λ is applied to the previous variance estimate
• This creates an exponentially decaying weighting scheme where more recent observations receive higher weights
• The formula uses the previous period's return (rₙ₋₁²), not the current period's return