Question

You run a regression of a stock's excess return on the market's excess return. The resulting equation is: y = 0.6x +0.05, and the R-squared is 0.48. (a) On average, how much did this stock price change if the market rose 1%? (b) What is the proportion of this stock's risk that is firm specific? (c) What does this model say is the stock's expected return when the market is 0%? IF using Excel, please show all steps.

Answer 1

y = 0.6x + 0.05

In this equation y is the stock's expected return

0.6 is the beta coefficient

x is change in market

0.05 is the alpha value for the stock

a) If the market increase by 1 percent it means the value of x is 1 and the stock will increase by the

(beta coefficient*x) + alpha

So, y = 0.6*(1%) + 0.05

y = 0.06+0.05

y = 0.11 or y= 1.1%

b) Only the alpha value that is 0.05 is firm specific becuse value of x is driven by market returns.

c) If market is 0%, it means value of x = 0%

So, y = 0.6*0% + 0.05

y= 0.05 or y = 5%