Estimation and Testing of Capital Asset Pricing Model The capital asset pricing model (CAPM) is an important model in the field of finance. It explains variations in the rate of return on a security as a function of the rate of return on a portfolio consisting of all publicly traded stocks, which is called the market portfolio. Generally the rate of return on any investment is measured relative to its opportunity cost, which is the return on a risk free asset. The resulting difference is called the risk premium, since it is the reward or punishment for making a risky investment. The CAPM says that the risk premium on security j is proportional to the risk premium on the market portfolio. That ;-r; = B;(P.-r;) (1) where r; and rare the returns to security, and the risk-free rate, respectively, rm is the return on the market portfolio, and B; is the beta value of security j. A stock's beta is important to investors since it reveals the stock's volatility. It measures the sensitivity of security j's return to variation in the whole stock market. As such, values of beta less than 1 i.e. p 1) indicates an aggressive stock. Investors usually want an estimate of a stock's beta before purchasing it. The "econometric models of CAPM can be obtained by including an intercept and an error term in the above model, i.e. "; -r = a,+B, (.-r,)+e. (2) The data file capam4.wfl includes the monthly returns of six firms, Microsoft (ms), GE (ge), GM (gm), IBM (ibm), Disney (disney), and Mobil-Exxon (mex), the rate of return on the market portfolio (mkt), and the rate of return on the risk free asset (riskfree). The data also includes the risk premium on the market portfolio (rp_mkt = r.-r,) and the risk premiums for Microsoft (rp_ms), GE (rp_ge), GM (rpm), IBM (rp_ibm), Disney (rp_disney), and Mobil-Exxon (rp_mex). The 132 observations cover January 1998 to December 2008. The data is available from the LMS. 6. What is the RP for the regression? Interpret it