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 to be

Question

Quizplus · Accepted Answer

If the CAPM is valid, the expected return for any stock should be equal to the risk-free rate plus a premium based on the stock's beta. Therefore, the coefficient for the constant term (g₀) should be equal to the risk-free rate. Any deviation from this would suggest that the CAPM is not valid. In this equation, if g₀ is not equal to 0, it would suggest that the constant term is not equal to the risk-free rate, indicating a violation of the CAPM. Therefore, the best choice is A) 0.

Consider the Regression Equation