1. What does the mean of ui,t, that is, E(ui,t), equal to?

2. What does the CAPM imply about the intercept, i?

3. Write down a formula for the slope estimate, bi. Explain why bi can be used as an estimator for the CAPMs .

4. Explain why the market model is a valid way of estimating the CAPM. (Hint: Recall that regression is a tool for modeling conditional means).

5. In your own words, explain the intuitive meaning of the term unbiased estimator. Use derivations on the slides to argue that bi is an unbiased estimator of the stocks . Write down formulas. Explain every single step in detail.

6. In your own words, explain the intuitive meaning of the term consistent estimator. What does it imply practically about our ability to recover the true value of ?

The Capital Asset Pricing Model (CAPM) can be written as E(R;) = 3; E(RM), where Ri is the excess return on a stock i (in excess of the risk-free rate), RM is the ex- cess return on the aggregate market index (e.g., S&P 500), and B; is a measure of stock's systematic risk - also known as stock's beta - given by: Bi Cov(R, RM var(RM) The first step in using the CAPM is to estimate the stock's beta using the market model. The market model can be written as: Rit = 0; +b;RM,1+ Wit, where Ri,t is the excess return for security i at time t, Rm,t is the excess return on the aggre- gate market index (e.g., S&P 500) at time t, and Ui,t is an iid (independent and identically distributed) random disturbance term. The Capital Asset Pricing Model (CAPM) can be written as E(R;) = 3; E(RM), where Ri is the excess return on a stock i (in excess of the risk-free rate), RM is the ex- cess return on the aggregate market index (e.g., S&P 500), and B; is a measure of stock's systematic risk - also known as stock's beta - given by: Bi Cov(R, RM var(RM) The first step in using the CAPM is to estimate the stock's beta using the market model. The market model can be written as: Rit = 0; +b;RM,1+ Wit, where Ri,t is the excess return for security i at time t, Rm,t is the excess return on the aggre- gate market index (e.g., S&P 500) at time t, and Ui,t is an iid (independent and identically distributed) random disturbance term