27 Pages

Simple Linear Regression; CAPM and Beta

ByStanley L. Sclove

This chapter begins with an example of simple linear regression. Then the Capital Assets Pricing Model (CAPM), which may be viewed as a particular application of simple linear regression to finance, is considered. The CAPM is regression through the origin, with only a slope parameter. Next, the usual simple linear regression model with both slope and intercept is treated. The modification of the CAPM with intercept as well as slope is discussed. The word "simple" in the phrase simple linear regression refers to the fact that is being described in terms of a single explanatory variable. In "multiple" regression, a topic of the chapter after this one, a response variable is described in terms of several explanatory variables. A linear combination of parameters is called a linear parametric function.