Consider the following linear regression model: The b i in the regression measur

Question

Consider the following linear regression model:

The bi in the regression

measures the sensitivity of the security to market risk.

measures the historical performance of the security relative to the expected return predicted by the SML.

measures the diversifiable risk in returns.

measures the deviation from the best fitting line and is zero on average.

measures the sensitivity of the security to market risk.

measures the historical performance of the security relative to the expected return predicted by the SML.

measures the diversifiable risk in returns.

measures the deviation from the best fitting line and is zero on average.

Explanation / Answer

The linear regression equation is comprised of two major parameters alpha (ai), and beta (bi). The first one alpha (ai) measures the historical performance of secuity relative to the expected return predicted by SML. The other one Beta (bi) measures the senstivity of secuirty relative to market risk. Thus the bi in regression measures the senstivity of security relative to the market risks.

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