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IAI Actuarial Core Principles · Economic Modelling · Capital Asset Pricing Model (CAPM)

Empirical tests of the CAPM often regress excess returns on beta and find that the fitted security market line has a lower slope and higher intercept than the CAPM predicts. Which statement best describes this finding?

A flatter line with higher intercept means low-beta assets earned more than CAPM predicts and high-beta assets earned less. This classic empirical pattern is inconsistent with the standard CAPM, and is closer to Black's zero-beta version of the model.

  1. ALow-beta assets earned higher returns than CAPM predicts and high-beta assets lower, which is a flatter line than predictedCorrect
  2. BHigh-beta assets earned much more than CAPM predicts, a steeper line
  3. CBeta has a negative relationship with return in every sample
  4. DReturns are exactly proportional to beta, confirming the model
  5. The intercept equals zero, confirming that there is no zero-beta premium

Explanation

A flatter fitted line with higher intercept means low-beta assets outperform the CAPM prediction and high-beta assets underperform it. This is the classic empirical finding against the standard CAPM, consistent with a zero-beta (Black) version. A steeper line or an intercept of zero would be consistent with the CAPM or the opposite pattern.

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