Consider the following model for the mean of asset returns 𝑟 𝑡 : 𝑟 𝑡 = 𝛼 + 𝛽 𝑧 𝑡 − 1 + 𝜀 𝑡 where 𝑧 𝑡 − 1 is a predictor of the returns. The model for the volatility is 𝜀 𝑡 = ℎ 𝑡 𝑢 𝑡 ℎ 𝑡 = 𝜇 * + 𝜙 1 * 𝜀 𝑡 − 1 2 + 𝜙 2 * 𝜀 𝑡 − 2 2 + 𝜙 3 * 𝜀 𝑡 − 3 2 𝔼 𝑡 − 1 ( 𝑢 𝑡 ) = 0 𝔼 𝑡 − 1 ( 𝑢 𝑡 2 ) = 1 What is the conditional expected value of the returns 𝔼 𝑡 − 1 ( 𝑟 𝑡 ) ? Choose the best answer below. Single choice

A

𝔼 𝑡 − 1 ( 𝑟 𝑡 ) = 𝛼 1 − 𝛽

B

𝔼 𝑡 − 1 ( 𝑟 𝑡 ) = 𝛽 𝑟 𝑡 − 1 + 𝛼

C

𝔼 𝑡 − 1 ( 𝑟 𝑡 ) = 𝛼 + 𝛽 𝑧 𝑡 − 1

D

𝔼 𝑡 − 1 ( 𝑟 𝑡 ) = 𝛽 𝑧 𝑡 − 1

E

𝔼 𝑡 − 1 ( 𝑟 𝑡 ) = 𝑧 𝑡 − 1

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