An analyst has run several regressions hoping to predict stock returns, and wants to translate this into an economic interpretation for his clients.
Return = 3.0 + 2.0Beta – 0.0001MarketCap (in billions) + ε
A correct interpretation of the regression most likely includes:
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The coefficient of MarketCap is 0.01%, indicating that larger companies have slightly smaller returns. Note that a company with no market capitalization would not be expected to have a return at all. Error terms are typically assumed to be normally distributed with a mean of zero.
Mary Steen estimated that if she purchased shares of companies who announced restructuring plans at the announcement and held them for five days, she would earn returns in excess of those expected from the market model of 0.9%. These returns are statistically significantly different from zero. The model was estimated without transactions costs, and in reality these would approximate 1% if the strategy were effected. This is an example of:
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The abnormal returns are not sufficient to cover transactions costs, so there is no economic significance to this trading strategy. This is not an example of market inefficiency because excess returns are not available after covering transactions costs.
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