Beta is often estimated by linear regression. A model often used is called the market model, which is In this regression Rt is the return on the equity and Rft is the risk-free rate for the same period. RMt is the return on a stock market index such as the FTSE 100 index. β

i is the regression intercept, and βi is the slope (and the equity’s estimated beta). σt represents the residuals for the regression. What do you think is the motivation for this particular regression? The intercept, αi

, is often called Jensen’s alpha. What does it measure? If an asset has a positive Jensen’s alpha, where would it plot with respect to the SML? What is the financial interpretation of the residuals in the regression?