The index model for stock A has been estimated with the following result:
R_A= 0.01 + 0.9R_M+ e_A
If σ_M= 0.25 and R²_A= 0.25,the standard deviation of return of stock A is _________.

Question

Quizplus · Accepted Answer

The formula for the standard deviation of stock A is: σA = σe / (1 - β) Where: σe = standard deviation of error term (given as σ²_A = 0.25) β = slope coefficient (given as 0.9) Substituting the values in the formula, we get: σA = 0.25 / (1 - 0.9) = 0.25 / 0.1 = 2.5 Therefore, the standard deviation of return of stock A is 2.5%, which is equal to 0.025. Thus, the best choice is C (0.4500).

The Index Model for Stock a Has Been Estimated with the Following