Market Risk Premium: Empirical Issues and Historical Trends

What does CAPM stand for?

Common Average Portfolio Method
Credible Asset Price Model
Capital Asset Pricing Model (correct)
Capital Asset Portfolio Management

According to the CAPM, what factor determines the expected return of a stock within a portfolio?

Historical Performance of the stock
Standard Deviation of the stock's returns
Number of shares outstanding
Correlation of the stock with the rest of the assets in the portfolio (correct)

In the context of Jensen's Alpha, what does a negative alpha for a stock indicate?

The stock is overvalued
The stock is less risky than average
The stock has high potential for growth
The stock has underperformed compared to the market (correct)

What does it mean if αi in the context of improving a portfolio using share i is equal to zero?

Neither buying nor short-selling share i will improve the portfolio (C) Signup and view all the answers

Which characteristic would lead a stock to help improve a portfolio according to the text?

Low correlation with other assets in the portfolio (C) Signup and view all the answers

If a stock is positioned above the Security Market Line (SML) and has a positive alpha, what does this imply according to the text?

The stock has performed better than expected given its riskiness (C) Signup and view all the answers

What is the formula for calculating the standard error required to be 95% confident in the historical market risk premium over a very long run?

σM / √T (B) Signup and view all the answers

Why does survivorship bias in estimating historical beta tend to focus on the US markets?

US markets have a longer track record (A) Signup and view all the answers

What are some issues that may arise when estimating historical beta for an individual share using shorter return intervals?

Higher idiosyncratic risk (B) Signup and view all the answers

Why is it advised to use shorter return intervals when estimating beta for a portfolio compared to an individual share?

To reduce idiosyncratic risk (D) Signup and view all the answers

What does the CAPM Valuation method involve?

Forecasting cash flows of the company (C) Signup and view all the answers

What factor determines whether the estimates of beta for BP shares depend on using daily or weekly returns?

The choice between daily and weekly returns (D) Signup and view all the answers

How is the Market Risk Premium (MRP) calculated using dividend growth models?

By subtracting the real interest rate from the dividend yield (B) Signup and view all the answers

Why is it mentioned that it is essential to use long data runs when estimating beta, despite the potential problems with stability?

To gather more data for analysis (B) Signup and view all the answers

What does the Implied MRP represent?

The expected earnings next period divided by the required return on equity (D) Signup and view all the answers

How is the value of a company calculated using the CAPM Valuation method?

By forecasting future cash flows and then discounting them (C) Signup and view all the answers

What does the Market Risk Premium (MRP) calculation assume according to the text?

The return to shareholders comes only from dividends (C) Signup and view all the answers

In Portfolio Construction, what is done using a portfolio optimizer?

Constructing a portfolio based on optimization techniques (A) Signup and view all the answers

What is the primary purpose of forming portfolios of stocks with similar betas?

To investigate the pricing of beta and other characteristics (B) Signup and view all the answers

According to the CAPM, what is the expected value of E[g0,t- RF,t]?

It is equal to zero (B) Signup and view all the answers

What did early tests by Black, Jensen, Scholes, Fama, and MacBeth indicate about the pricing of Beta and idiosyncratic risk?

Beta was priced but idiosyncratic risk was not (C) Signup and view all the answers

Why does recent evidence suggest a flat relationship between Beta and returns?

Because Beta is not a significant factor in determining returns (B) Signup and view all the answers

What would be a possible reason not to test the CAPM on individual shares based on the text provided?

The lack of significance in idiosyncratic risk for stock returns (B) Signup and view all the answers

What is a key limitation mentioned in testing the CAPM using individual shares?

Inability to accurately measure the beta of each share (B) Signup and view all the answers

Why can the beta of portfolios be measured more accurately than individual shares?

Idiosyncratic risk is diversified away in portfolios (D) Signup and view all the answers

What does the anomalous evidence mentioned in the text suggest about expected returns?

Factors other than beta are important in determining expected returns (C) Signup and view all the answers

Which effect is NOT mentioned as a factor influencing expected returns beyond beta in the text?

The Size Effect (D) Signup and view all the answers

Why can forming portfolios based on prior measured beta help in testing the CAPM?

To increase dispersion of beta values in the portfolios (C) Signup and view all the answers

Which statement best explains why the CAPM may not work well according to the text?

Anomalies like the Small Firm Effect and Book-to-Market Effect defy CAPM predictions (A) Signup and view all the answers