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 nonzero slope coefficient test in CAPM is for determining the significance of the relationship between a security's expected return and market return. The stock's alpha (slope coefficient α) indicates positive abnormal returns when α is greater than zero and negative abnormal returns when α is less than zero. CAPM theory predicts alpha to be zero.

Step-by-step explanation:

The nonzero slope coefficient test in the Capital Asset Pricing Model (CAPM) is used to determine if there is a significant relationship between the expected return on a security and the return on the market. According to CAPM, the correct answers regarding the slope coefficient α, called the stock's alpha, are:

• Abnormal returns are positive when α > 0.
• Abnormal returns are negative when α < 0.
• The CAPM theory predicts α to be zero.

The alpha (α) represents the stock's expected return independent of the market's return, and a positive alpha suggests that the stock is expected to outperform the market (after adjusting for risk), while a negative alpha indicates an underperformance expectation. It is important to note that the slope coefficient β (beta) in CAPM actually measures the stock's volatility in relation to market fluctuations and not the alpha (α).