Q: The expected return-beta relationship represented in CAPM is tested through a two-stage procedure: first-pass and second-pass regression.

a). State the first pass regression. What are the inputs and outputs of the first-pass regression?

b). State the second pass regression. What are the inputs and outputs of the second-pass regression?

c). If the empirical SML is too flat, how accurate is CAPM in predicting the performance of high- or low- beta stocks?

d). What is the implication of a coefficient on 2 being positive and statistically significant?

e). What are the limitations of this approach?