Question: Beta is often estimated by linear regression. A model commonly used is called the market model, which is: Rit Rft = i +i[Rmt Rft]+it In

Beta is often estimated by linear regression. A model commonly used is called the market model, which is:

Rit Rft = i +i[Rmt Rft]+it

In this regression, Rit is the return on the stock i and Rft is the risk-free rate for the same period. Rmt is the return on a stock market index such as the S&P 500 index; i is the regression

intercept; i is the slope (and the stocks estimated beta); and it represents the residuals for the regression. The intercept, , is often called Jensens alpha. What does Jensens alpha measure? What is the financial interpretation of the residuals in the regression?

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