What is known as the characteristic line of modern investment analysis is simply the regression line obtained from the following model:
rit = αi + βirmt + ut
where rit = the rate of return on the ith security in time t
rmt = the rate of return on the market portfolio in time t
ut = stochastic disturbance term
In this model βi is known as the beta coef?cient of the ith security, a measure of market (or systematic) risk of a security.*
On the basis of 240 monthly rates of return for the period 1956-1976, Fogler and Ganapathy obtained the following characteristic line for IBM stock in relation to the market portfolio index developed at the University of Chicago†:
rˆit = 0.7264 + 1.0598rmt r 2 = 0.4710
se = (0.3001 ) (0.0728 ) df = 238
F1,238 = 211.896
a. A security whose beta coef?cient is greater than one is said to be a volatile or aggressive security. Was IBM a volatile security in the time period under study?
b. Is the intercept coef?cient signi?cantly different from zero? If it is, what is its practical meaning?