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FRM Part II · FRM Exam Part II · Alpha (and the Low-Risk Anomaly)

Over a long sample, low-beta stocks have earned CAPM alphas that are positive, while high-beta stocks have earned negative alphas. Which interpretation is most consistent with the low-risk anomaly?

Positive alphas for low-beta stocks and negative alphas for high-beta stocks mean realized returns increase less with beta than CAPM predicts. This describes a flatter security market line, which is the empirical signature of the low-risk anomaly.

  1. AThe security market line is flatter than CAPM predictsCorrect
  2. BThe security market line is steeper than CAPM predicts
  3. CBeta is uncorrelated with returns, so the SML is vertical
  4. DInvestors are compensated one-for-one for beta, as CAPM predicts

Explanation

If low-beta assets beat their CAPM-required return and high-beta assets fall short, realized returns rise less with beta than CAPM implies. That is a flatter security market line. A steeper line would imply the opposite alpha pattern.

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