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CFA Level I · CFA Level I Exam · The Capital Asset Pricing Model, Market Model, and Other Factor-Based Equity Models

An analyst regresses a stock's monthly returns on market returns and obtains a raw beta of 1.40. Using the Blume adjustment with weights of two-thirds on the raw beta and one-third on 1.0, the adjusted beta is closest to:

The adjusted beta is about 1.27. Weighting two-thirds on the raw beta of 1.40 gives 0.933, and one-third on 1.0 gives 0.333, totaling 1.267. The adjustment pulls extreme betas toward 1.0 because betas tend to revert toward the market average over time.

  1. A1.20
  2. B1.27Correct
  3. C1.60

Explanation

Adjusted beta = (2/3)(1.40) + (1/3)(1.0) = 0.9333 + 0.3333 = 1.267, about 1.27. Option A is the simple average of 1.40 and 1.0. Option C moves away from 1.0, the opposite of the mean-reversion rationale.

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