Consider the regression equation: r_i - r_f = g₀ + g₁b₁ + g₂s²(e_i) + e_it
Where:
R_i - r_f = 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, g₀, has to be

Question

Quizplus · Accepted Answer

CThe CAPM (Capital Asset Pricing Model) posits that the expected excess return on a stock (the return over the risk-free rate) is proportional to the expected excess return on the market, scaled by the stock's beta. If CAPM holds true, the intercept of the regression (g0) should be statistically indistinguishable from zero, as the model explains returns with market excess returns and beta, leaving no room for a constant term. Additionally, the risk-free rate is not the intercept but part of the calculation for excess returns; thus, it does not represent the expected coefficient for g0 in the regression equation.

Consider the Regression Equation: Ri - Rf = G0

Consider the Regression Equation: R_i - R_f = G₀