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1. (a) The capital asset pricing model (CAPM) can be written as, E[Ri]=Rf+i(E[Rm]Rf)foralli The first step in using the CAPM is to estimate the stock's
1. (a) The capital asset pricing model (CAPM) can be written as, E[Ri]=Rf+i(E[Rm]Rf)foralli The first step in using the CAPM is to estimate the stock's using the market model. The market model can be written as, (b) Rit=i+iRmt+uitforalli where Rit is the excess return for security i at time t,Rmt is the excess return on a proxy for the market portfolio at time t, and ut is an iid random disturbance term. The cofficient in this case is also the CAPM beta for security i. Suppose that you had estimated (a) and found that the estimated value of ^ for a stock was 1.147. The variance of the market risk premium is 0.01351 and SE(u^it)=0.0497. A city analyst has told you that this security closely follows the market, but that is no more risky, on average, than the market. This can be tested by the null hypotheses that the value of is one. The model is estimated over sixty-two daily observations. Test this hypothesis against a one-sided alternative that the security is more risky than the market, at the 5% level. Write down the null and alternative hypothesis. What do you conclude? Are the analyst's claims empirically verified
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