Final answer:
In asset pricing model testing, the average excess return for each of the 100 test portfolios is estimated to determine the model's empirical validity. This helps to understand each portfolio’s performance compared to the risk-free rate, serving as a baseline in the evaluation of the model's predictive power.
Step-by-step explanation:
In the first step of testing the empirical validity of asset pricing models for 100 test portfolios, what is typically estimated is the average excess returns each portfolio generates. The economist will compare these estimated returns with the actual outcomes from the stock market to determine how well the model predicts real-world data. While market betas, oil price sensitivities, and the excess return of oil might also be of interest, they would be relevant to testing the validity of asset pricing models that are specifically designed to address those particular market factors. The average excess returns provide the baseline for understanding portfolio performance relative to the risk-free rate.
An economic model is a theoretical construct that economists use to understand, explain, and predict economic phenomena. Portfolio diversification is a risk management strategy that involves spreading investments across various financial assets to reduce the impact of any one asset's performance on the portfolio's overall returns. The securities exchange is the marketplace where stocks, bonds, and other types of securities are bought and sold. Analyzing the risk involved in different types of financial assets is crucial for investors, as they need to balance potential returns against their risk profiles and investment goals.