Question

The nonzero slope coefficient test is used for a renowned financial application referred to as the capital asset pricing model (CAPM).The model y = α + βx + ɛ, is essentially a simple linear regression model that uses α and β, in place of the usual β0 and β1, to represent the intercept and the slope coefficients, respectively. Which of the following is true about the slope coefficient α, called the stock's alpha?

Select that apply!
Multiple select question.
A. Abnormal returns are positive when α > 0
B. Abnormal returns are negative when α < 0.
C. Measures how sensitive the stock's return is to changes in the level of the overall market
D. The CAPM theory predicts α to be zero

Answer 1

The slope coefficient α in the CAPM model, also known as the stock's alpha, is used to measure abnormal returns and the stock's sensitivity to market changes. It is predicted to be zero by the CAPM theory. Positive α indicates outperformance, while negative α indicates underperformance.

Step-by-step explanation:

The slope coefficient α in the capital asset pricing model (CAPM) is called the stock's alpha. The CAPM theory predicts that the alpha α is zero.

A nonzero alpha indicates that the stock's returns are either abnormal (positive or negative). Abnormal returns are positive when α > 0 and negative when α < 0.

Furthermore, the slope coefficient α measures how sensitive the stock's return is to changes in the level of the overall market.

It reflects the excess return of the stock compared to what is expected based on its beta coefficient.

If α is positive, it means that the stock is outperforming the market, while a negative α indicates underperformance.