why the expected return is just the intercept? why not take other factor into consideration?
Please addd some comments
Assume you are considering forming a common stock portfolio consisting of 25% Stonebrook Corporation (Stone) and 75% Rockway Corporation (Rock). As expressed in the two-factor returns models presented below, both of these stocks’ returns are affected by two common factors: surprises in interest rates and surprises in the unemployment rate.
RStone = 0.11 + 1.0FInt + 1.2FUn + εStone RRock = 0.13 + 0.8FInt + 3.5FUn + εRock
Assume that at the beginning of the year, interest rates were expected to be 5.1% and unemployment was expected to be 6.8%. Further, assume that at the end of the year, interest rates were actually 5.3%, the actual unemployment rate was 7.2%, and there were no company-specific surprises in returns. This information is summarized in Table 1 below:
Table 1: Expected versus Actual Interest Rates and Unemployment Rates
Actual
Expected
Company-specific returns surprises
Interest Rate
0.053
0.051
0.0
Unemployment Rate
0.072
0.068
0.0
What is the expected return for Stonebrook?
A) 11.0%. B) 13.0%. C) 13.2%.
Your answer: A was correct!
The expected return for Stonebrook is simply the intercept return (ai) of 0.11, or = 11.0%. (Study Session 18, LOS 66.j, k)