Based on the information in Exhibit 1, the expected return for Portfolio 1 is closest to:
When using a macroeconomic factor model, the expected return is the intercept (when all model factors take on a value of zero). The intercept coefficient for Portfolio 1 in Exhibit 1 is 2.58.
I don’t understand the explanation. Kindly help
The outcome of the macroeconomic factor formula is the expected return of a portfolio adjusted for macro factors surprises. When all these factors as expected , then macroeconomic factor model adjust for nothing, thus the expected return ( adjusted by the macroeconomic factor model) is the intercept (the expected return).
Thank you, but I’m still confused about how the factors are expected. Factor surprises were given.
The “expected” return is what you get if the factors are what was predicted.
Ona simple model.
Return = 2% + Factor(GDP) x GDP surprise.
Factor*GDP) = 1.5
GDP predicted to be 3%, GDP turns out to be 3%.
Return = 2% + 1.2 x (0) = 2%
if GDP was 5%
Return = 2% + 1.2 x (5% - 3%) = 4.4%
So you expectation is the GDP will be as predicted so expected return = intercept as you are not expectng surprises. If was expected it would be be a surprise.
Ohh. It was expected. I get it now !!! Thank you