Deck 13: Empirical Evidence on Security Returns

Question 1

Consider the regression equation: r_i - r_f = g₀ + g₁b_i + g₂s²(e_i) + e_it
where:
R_i - r_t = the average difference between the monthly return on stock i and the monthly risk-free rate
B_i = the beta of stock i
S²(e_i) = a measure of the nonsystematic variance of the stock i
If you estimated this regression equation and the CAPM was valid, you would expect the estimated coefficient, g₁, to be

A)0.
B)1.
C)equal to the risk-free rate of return.
D)equal to the average difference between the monthly return on the market portfolio and the monthly risk-free rate.

Answer 1

D

Question 2

If a market proxy portfolio consistently beats all professionally-managed portfolios on a risk-adjusted basis, it may be concluded that

A)the CAPM is valid.
B)the market proxy is mean/variance efficient.
C)the CAPM is invalid.
D)the CAPM is valid and the market proxy is mean/variance efficient.

Answer 2

D

Question 3

Kandel and Stambaugh (1995) expanded Roll's critique of the CAPM by arguing that tests rejecting a positive relationship between average return and beta are demonstrating

A)the inefficiency of the market proxy used in the tests.
B)that the relationship between average return and beta is not linear.
C)that the relationship between average return and beta is negative.
D)the need for a better way of explaining security returns.

Answer 3

A

Question 4

The expected return/beta relationship is used

A)by regulatory commissions in determining the costs of capital for regulated firms.
B)in court rulings to determine discount rates to evaluate claims of lost future incomes.
C)to advise clients as to the composition of their portfolios.
D)All of the options are correct.

Question 5

In the empirical study of a multifactor model by Chen, Roll, and Ross, a factor that did not appear to have significant explanatory power in explaining security returns was

A)the change in the expected rate of inflation.
B)the risk premium on corporate bonds.
C)the unexpected change in the rate of inflation.
D)industrial production. Of the variables tested, Chen, Roll, and Ross found that the risk premium on corporate bonds, the unexpected change in the rate of inflation, and industrial production were significant predictors of security returns.

Question 6

In the results of the earliest estimations of the security market line by Miller and Scholes (1972), it was found that the average difference between a stock's return and the risk-free rate was ________ to its nonsystematic risk and ________ to its beta.

A)positively related; negatively related
B)negatively related; positively related
C)positively related; positively related
D)negatively related; negatively related

Question 7

In the results of the earliest estimations of the security market line by Miller and Scholes (1972), it was found that the average difference between a stock's return and the risk-free rate was ________ to its beta.

A)positively related
B)negatively related
C)unrelated
D)inversely related

Question 8

In the 1972 empirical study by Black, Jensen, and Scholes, they found that the estimated slope of the security market line was _______ what the CAPM would predict.

A)flatter than
B)equal to
C)steeper than
D)one-half as much as

Question 9

In the 1972 empirical study by Black, Jensen, and Scholes, they found that the estimated slope of the security market line was _______ what the CAPM would predict.

A)higher than
B)equal to
C)less than
D)twice as much as

Question 10

Fama and MacBeth (1973) found that the relationship between average excess returns and betas was

A)linear.
B)nonexistent.
C)as expected, based on earlier studies.
D)linear and as expected, based on earlier studies.

Question 11

Consider the regression equation: r_i - r_f = g₀ + g₁b_i + e_it
where:
R_i - r_f = the average difference between the monthly return on stock i and the monthly risk-free rate
B_i = the beta of stock i
This regression equation is used to estimate

A)the benchmark error.
B)the security market line.
C)the capital market line.
D)the benchmark error and the security market line.

Question 12

Consider the regression equation: r_i - r_f = g₀ + g₁b₁ + g₂s²(e_i) + e_it
Where:
R_i - r_f = the average difference between the monthly return on stock i and the monthly risk-free rate
B_i = the beta of stock i
S²(e_i) = a measure of the nonsystematic variance of the stock i
If you estimated this regression equation and the CAPM was valid, you would expect the estimated coefficient, g₀, has to be

A)0.
B)1.
C)equal to the risk-free rate of return.
D)equal to the average difference between the monthly return on the market portfolio and the monthly risk-free rate.

Question 13

In the 1972 empirical study by Black, Jensen, and Scholes, they found that the risk-adjusted returns of high beta portfolios were _____________ the risk-adjusted returns of low beta portfolios.

A)greater than
B)equal to
C)less than
D)unrelated to

Question 14

Given the results of the early studies by Lintner (1965) and Miller and Scholes (1972), one would conclude that

A)high beta stocks tend to outperform the predictions of the CAPM.
B)low beta stocks tend to outperform the predictions of the CAPM.
C)there is no relationship between beta and the predictions of the CAPM.
D)high beta stocks and low beta stocks tend to outperform the predictions of the CAPM.

Question 15

Consider the regression equation: r_i - r_f = g₀ + g₁b_i + g₂s²(e_i) + e_it
Where:
R_i - r_t = the average difference between the monthly return on stock i and the monthly risk-free rate
B_i = the beta of stock i
S²(e_i) = a measure of the nonsystematic variance of the stock i
If you estimated this regression equation and the CAPM was valid, you would expect the estimated coefficient, g₂, to be

A)0.
B)1.
C)equal to the risk-free rate of return.
D)equal to the average difference between the monthly return on the market portfolio and the monthly risk-free rate.

Question 16

The CAPM is not testable unless

A)the exact composition of the true market portfolio is known and used in the tests.
B)all individual assets are included in the market proxy.
C)the market proxy and the true market portfolio are highly negatively correlated.
D)the exact composition of the true market portfolio is known and used in the tests, and all individual assets are included in the market proxy.

Question 17

Consider the regression equation: r_it - r_ft = a_i + b_i(r_mt - r_ft) + e_it
Where:
R_it = return on stock i in month t
R_ft = the monthly risk-free rate of return in month t
R_mt = the return on the market portfolio proxy in month t
This regression equation is used to estimate

A)the security characteristic line.
B)benchmark error.
C)the capital market line.
D)All of the options are correct.

Question 18

In the results of the earliest estimations of the security market line by Lintner (1965) and by Miller and Scholes (1972), it was found that the average difference between a stock's return and the risk-free rate was ________ to its nonsystematic risk.

A)positively related
B)negatively related
C)unrelated
D)related in a nonlinear fashion

Question 19

__________ argued in his famous critique that tests of the expected return/beta relationship are invalid and that it is doubtful that the CAPM can ever be tested.

A)Kim
B)Markowitz
C)Modigliani
D)Roll

Question 20

If a professionally-managed portfolio consistently outperforms the market proxy on a risk-adjusted basis and the market is efficient, it should be concluded that

A)the CAPM is invalid.
B)the proxy is inadequate.
C)either the CAPM is invalid or the proxy is inadequate.
D)the CAPM is valid and the proxy is adequate.

Question 21

Tests of multifactor models indicate

A)the single-factor model has better explanatory power in estimating security returns.
B)macroeconomic variables have no explanatory power in estimating security returns.
C)it may be possible to hedge some economic factors that affect future-consumption risk with appropriate portfolios.
D)multifactor models do not work.

Question 22

Fama and French (2002) studied the equity premium puzzle by breaking their sample into subperiods and found that

A)the equity premium was largest throughout the entire 1872-1999 period.
B)the equity premium was largest during the 1872-1949 subperiod.
C)the equity premium was largest during the 1950-1999 subperiod.
D)the differences in equity premiums for the three time periods were statistically insignificant.

Question 23

Fama and French (1992) found that

A)firm size had better explanatory power than beta in describing portfolio returns.
B)beta had better explanatory power than firm size in describing portfolio returns.
C)beta had better explanatory power than book-to-market ratios in describing portfolio returns.
D)macroeconomic factors had better explanatory power than beta in describing portfolio returns.

Question 24

Studies by Chan, Karceski, and Lakonishok (2003) and La Porta, Lakonishok, Shleifer, and Vishny (1997) report that

A)the value premium is a manifestation of market irrationality.
B)the value premium is a rational risk premia.
C)the value premium is a statistical artifact found only in the U.S.
D)All of the options are correct.

Question 25

Tests of the CAPM that use regression techniques are subject to inaccuracies because

A)the statistical results used are almost always incorrect.
B)the slope coefficient of the regression equation is biased downward.
C)the slope coefficient of the regression equation is biased upward.
D)the intercept of the regression equation is biased downward.

Question 26

A major finding by Heaton and Lucas (2000) is that

A)the market rate of return does not help explain the rate of return of individual securities, and CAPM must be rejected.
B)the market rate of return does explain the rate of return of individual securities.
C)the change in proprietary wealth helps explain the rate of return of individual securities.
D)the market rate of return does not help explain the rate of return of individual securities, and CAPM must be rejected, but the change in proprietary wealth helps explain the rate of return of individual securities.

Question 27

The Fama and French three-factor model uses ___, ___, and ___ as factors.

A)industrial production; term spread; default spread
B)industrial production; inflation; default spread
C)firm size; book-to-market ratio; market index
D)firm size; book-to-market ratio; default spread

Question 28

Early tests of the CAPM involved

A)establishing sample data.
B)estimating the security characteristic line.
C)estimating the security market line.
D)All of the options are correct.

Question 29

Which of the following is a (are) result(s) of the Fama and French (2002) study of the equity premium puzzle? I) Average realized returns during 1950-1999 exceeded the internal rate of return (IRR) for corporate investments.
II) The statistical precision of average historical returns is far higher than the precision of estimates from the dividend-discount model (DDM).
III) The reward-to-variability ratio (Sharpe) derived from the DDM is far more stable than that derived from realized returns.
IV) There is no difference between DDM estimates and actual returns with regard to IRR, statistical precision, or the Sharpe measure.

A)I, II, and III
B)I and III
C)I and II
D)II and III

Question 30

According to Roll, the only testable hypothesis associated with the CAPM is

A)the number of ex-post mean-variance efficient portfolios.
B)the exact composition of the market portfolio.
C)whether the market portfolio is mean-variance efficient.
D)the SML relationship.

Question 31

Which of the following statements is true about models that attempt to measure the empirical performance of the CAPM?

A)The conventional CAPM works better than the conditional CAPM with human capital.
B)The conventional CAPM works about the same as the conditional CAPM with human capital.
C)The conditional CAPM with human capital yields a better fit for empirical returns than the conventional CAPM.
D)Adding firm size to the model specification dramatically improves the fit.

Question 32

Liew and Vassalou (2000) show that returns on style portfolios (SMB and HML)

A)seem like statistical flukes.
B)seem to predict GDP growth.
C)may be proxies for business cycle risk.
D)seem to predict GDP growth and may be proxies for business cycle risk.

Question 33

A study by Mehra and Prescott (1985) found that historical average excess returns

A)have been too small to be consistent with rational security pricing.
B)have been too large to be consistent with rational security pricing.
C)have been too small to be consistent with fractional security pricing.
D)prove CAPM is incorrect.

Question 34

One way that Black, Jensen and Scholes overcame the problem of measurement error was to

A)group securities into portfolios.
B)use a two-stage regression methodology.
C)reduce the precision of beta estimates.
D)set alpha equal to one.

Question 35

In their multifactor model, Chen, Roll, and Ross found

A)that two market indexes, the equally-weighted NYSE and the value-weighted NYSE, were not significant predictors of security returns.
B)that the value-weighted NYSE index had the incorrect sign, implying a negative market risk premium.
C)expected changes in inflation-predicted security returns.
D)that two market indexes, the equally-weighted NYSE and the value-weighted NYSE, were not significant predictors of security returns and that the value-weighted NYSE index had the incorrect sign, implying a negative market risk premium.

Question 36

Which of the following would be required for tests of the multifactor CAPM and APT?

A)Specification of risk factors
B)Identification of portfolios that hedge these fundamental risk factors
C)Tests of the explanatory power and risk premiums of the hedge portfolios
D)All of the options are correct.

Question 37

Jagannathan and Wang (2006) find that the CCAPM explains returns ______ the Fama-French three-factor model, and that the Fama-French three-factor model explains returns ______ the traditional CAPM.

A)worse than; worse than
B)worse than; better than
C)better than; better than
D)better than; worse than

Question 38

An extension of the Fama-French three-factor model was introduced by

A)Black.
B)Scholes.
C)Carhart.
D)Jensen.

Question 39

Which of the following statements is false about models that attempt to measure the empirical performance of the CAPM? I) The conventional CAPM works better than the conditional CAPM with human capital.
II) The conventional CAPM works about the same as the conditional CAPM with human capital.
III) The conditional CAPM with human capital yields a better fit for empirical returns than the conventional CAPM.

A)I only
B)II only
C)III only
D)I and II

Question 40

The Fama-French model I) is a useful tool for benchmarking performance against a well-defined set of factors.
II. premia are determined by market irrationality.
III. premia are determined by rational risk factors.
IV. is the reason that the premia is unsettled.
V. is not a useful tool for benchmarking performance against a well-defined set of factors.

A)I only
B)V only
C)I and II
D)I and IV

Question 41

An extension of the Fama-French three-factor model includes a fourth factor to measure

A)default spread.
B)term spread.
C)momentum.
D)industrial production.