Question

In a study conducted by Jagannathan and Wang, it was found that the performance of beta in explaining security returns could be considerably enhanced by: I. Including the unsystematic risk of a stock II. Including human capital in the market portfolio III. Allowing for changes in beta over time

Answer 1

Answer:

II. Including human capital in the market portfolio

Explanation:

Beta refers is a measure of systematic risk of a portfolio which is defined as degree of responsiveness of security return with that of the market return.

Market portfolio represents, the rate of return all the securities in the market currently earn.  An investor would require excess of market portfolio return over risk free rate of return, based upon the sensitivity of portfolio return to market return i.e beta.

Jagannathan and Wang conducted a study testing capital asset pricing model which was developed by William Sharpe and John Lintner.

Under their study, Jagannath and Wang included human capital beta in the market portfolio. while evaluating returns from a hundred stocks portfolio. They observed, the coefficient of determination i.e $r^{2}$ rose from 2% to 75% upon addition of human capital.

Thus, the method found how beta performance in explaining security returns could be enhanced upon inclusion of human capital.