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A financial econometrician thinks that the stock market crash of October 1987 fundamentally changed the risk return relationship given by the CAPM equation. He decides to test this hypothesis using a Chow test. The model is estimated using monthly data from January 1980 - December 1995, and then two separate regressions are run for the sub-periods corresponding to data before and after the crash. The model is
so that the excess return on a security at time t is ...
A Chow Test question is answered in the solution.