getting a little confused on the market model - I know the formula is a + B(Rm) + e is the "a’ in this case mean to be the Rf rate, similar to the CAPM? Or is it meant to be the security’s alpha?
It is the return on the security that is unrelated to the market. It could be interpreted as nonsystematic risk. It is also the expected return on the security when the return on the market = 0.
a= avarage return of the asset
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That is not true Audrey… If the return on the security can be completey explained by the return on the market then a=0, however the expected return would be equal to the expected return on the market multiplied by its sensitivity to the market… a is not the rf and it is not the same as the alpha you would get from the sml, and definitely not the average return of the asset
was coming back to this today, just want to make sure i got it… R = a +B(Rm) + e B(Rm) would be beta x the expected return on the market…this is NOT an equity risk premium (i.e. we don’t subtract the RF rate as we do in the CAPM). a = the component of the security’s return that is driven by firm-specific risk. E is just an error term… is that about right?
smileygladhands Wrote: ------------------------------------------------------- > R = a +B(Rm) + e > > B(Rm) would be beta x the expected return on the > market > > a = the component of the security’s return that is > driven by firm-specific risk. > > E is just an error term this is correct - this model is based on the relationship of the security to the market. B(Rm) is the security’s return based on its relationship to the market. alpha (a) is the return that the security earns that is beyond its relationship to the market; its ‘firm-specific’ or ‘unique’ risk based return. e is the error term assuming a regression.
a is the average return on the asset that is not related to the markets return. It’s the same concept as b0 in a linear regression.