Please answer the following questions!

2. (Single Index Model; 90 pts, 10 pts each) SI model for asset returns has the form Rit = ait B;RMt + Eit, Eit ~ iid N (0, oz) (2) i = 1, ..., N assets, t = 1, ..., T time periods, where Rit denotes the cc return on asset i at time t, and RM: denotes the return on a market index portfolio at time t. (a) In the SI model, what are the interpretations of S; and o ? (b) SI model with large portfolios can be constructed as N Rit = Rip,t = a + BRMt + Et, where a = N Can B=~ EB; and at = i=1 In a large "well diversified" portfolio, we could diversify away all non-market variance, hence Rp,t ~ a + BRMt. Briefly explain how this is possible. We may use the S&P 500 index as the "market return" for our SI model. The following represents R linear regression output from estimating the SI model for the four North- west stocks (Boeing, Microsoft, Nordstrom and Starbucks) using monthly continuously com