Question

Returns on common stocks in the United States and overseas appear to be growing more closely correlated as economies become more interdependent. Suppose that the following population regression line connects the total annual returns (in percent) on two indexes of stock prices:

MEAN OVERSEAS RETURN = ?0.07 + 0.20 ? U.S. RETURN

1. What does this number say about overseas returns when the U.S. market is flat (0% return)? (Fill in blanks)

This says that the mean overseas return is ______ % when the U.S. return is 0%.

2.What does this number say about the relationship between U.S. and overseas returns? (Fill in blanks)

This says that when the U.S. return changes by 1%, the mean overseas return changes by ______ %.

3.We know that overseas returns will vary in years when U.S. returns do not vary. Write the regression model based on the population regression line given above. (Fill in blanks)

y_i = _____+ ______ x_i + ?_i, where y_i and x_i are observed overseas and U.S. returns in a given year, and ?_i are independent N(0, ?) variables.

Answer 1

1. Mean overseas return is -0.07% when the U.S. reutrn is 0%

2. When the U.S. return changes by 1%, the mean overseas return changes by 0.20%

3. Regression model:

yi = -0.07 + 0.20 xi + ?i