Asset pricing models...[Fill in the blank]

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CAPM states E[R_i] = R_f + beta_i (E[R_M] − R_f), so expected returns are tied to systematic (market) risk, not unsystematic risk. 1) Relevant knowledge points and concepts - Systematic (market or factor) risk is non-diversifiable and priced; unsystematic (idiosyncratic or firm-specific) risk is diversifiable and not priced in standard asset-pricing models. - CAPM and multi-factor models (Arbitrage Pricing Theory, Fama–French, etc.) express expected excess return as a linear function of exposures (betas/loadings) to priced factors: E[R_i] − R_f = Σ_j λ_j b_{ij}, where λ_j are factor risk premia and b_{ij} are factor loadings. - Assets that provide consumption hedges (do well in bad states) typically have negative loading on a bad-times factor; if that factor has a positive price (λ > 0), a negative loading reduces expected return. 2) Step-by-step reasoning - Evaluate option (a): It claims asset-pricing models relate expected returns to unsystematic risk. CAPM and factor models relate returns to systematic risk (betas/loadings). Unsystematic risk is diversifiable, so (a) is false. - Evaluate option (c): Same as (a) using the term “firm-specific” (synonymous with unsystematic). Thus (c) is false. - Evaluate option (d): It says models predict higher expected returns for stocks that do badly in good times and well in bad times. “Do well in bad times” implies negative loading on a bad-times factor; with positive factor price λ, contribution λ·b < 0, lowering expected return. So models predict LOWER, not higher, expected returns for such hedging stocks. Thus (d) is false. 3) Intermediate “calculation” (algebraic illustration) E[R_i] − R_f = λ · b_i. If b_i < 0 (stock does well in bad times) and λ > 0, then λ·b_i < 0 ⇒ lower expected excess return. 4) Why the correct answer is correct Because each of the explicit options (a), (c), and (d) contradicts core properties of standard asset-pricing models (they price systematic, not unsystematic, risk, and they reward exposure that hurts investors in bad states). Therefore none of those statements is correct. 5) Why other options are incorrect (brief) - (a) and (c): wrong wording—models price systematic factors, not unsystematic/firm-specific risk. - (d): reversed implication—assets that hedge bad times typically command lower expected returns. Conclusion: None of the provided options is correct; therefore the correct choice is b. None of the options provided.

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