This module is part of the 2027 curriculum. You are following the 2026 curriculum, where it is not taught in this form. Switch if you are sitting the exam under the 2027 curriculum.
Lesson 1 of 6 · 15 min
Return-generating models, the market model and beta
Return-generating models link expected return to risk factors; with the market as the only factor, an asset's sensitivity to the market, its beta, measures its systematic risk.
In short
- A return-generating model estimates expected return from given parameters. The general form is a multi-factor model; factors can be macroeconomic, fundamental or statistical.
- Fama-French add size and book-to-market to the market factor; Carhart adds momentum.
- The single-index model: . It splits total variance into (systematic) + (nonsystematic).
- The market model is estimated by regression; it is used to estimate beta and abnormal returns.
- . The market's beta is 1, the risk-free asset's is 0, and the average stock's beta is 1.
- Short estimation windows are more current but noisier; three to five years is more accurate but may be out of date.
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