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The question is shown below 5. Testing the CAPM model The following is the well-known Capital Asset Pricing Model (CAPM): R =R+B.(Rm-R) where R, is

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5. Testing the CAPM model The following is the well-known Capital Asset Pricing Model (CAPM): R =R+B.(Rm-R) where R, is the return on individual asset i, R, is the risk free rate of return, Rm is the return on the market portfolio, and (Rm-R) is the market excess return over the risk-free asset. Suppose you want to test the CAPM model using the IBM stock return. You ob- serve the following in the capital market: (i) over the last 15 years IBM stock generated, on average, 6.5% excess return over the risk-free asset (RIBM - R); (ii) over the same last 15 years, the average market excess return over the risk-free asset (Rm-R;) has been 4.5%; (iii) the variance of (Rm-R) is 15%; (iv) the covariance between (RIBM-R+) and (Rm-R) is 21.6%. Based on this information, how can test and conclude whether CAPM is indeed a good asset pricing model? (5 Marks)

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