Consider the regression equation:
R_i- r_f = g₀ + g₁b_i + g₂s²(e_i) + e_it
Where:
R_i - r_t = the average difference between the monthly return on stock i and the monthly risk-free rate
B_i= the beta of stock i
S²(e_i) = a measure of the nonsystematic variance of the stock i.
If you estimated this regression equation and the CAPM was valid,you would expect the estimated coefficient,g₂ to be

Question

Quizplus · Accepted Answer

According to the CAPM, the expected return on a security or portfolio should be proportional to its beta, which represents the systematic risk of the security or portfolio. Therefore, the coefficient on the beta, g_i, should be positive and nonzero in the regression equation. On the other hand, the coefficient on the nonsystematic variance, g₂s²(e_i), should be zero, because nonsystematic variance is diversified away in a well-diversified portfolio. Therefore, the best choice is A) 0.

Consider the Regression Equation