You believe there is a relationship between book-to-market ratios and subsequent returns. The output from a cross-sectional regression and a graph of the actual and predicted relationship between the book-to-market ratio and return are shown below.
Results from Regressing Returns on the Book-to-Market Ratio
A. You are concerned with model specification problems and regression assumption violations.
Focusing on assumption violations, discuss symptoms of conditional heteroskedasticity based on the graph of the actual and predicted relationship.
B. Describe in detail how you could formally test for conditional heteroskedasticity in this regression.
C. Describe a recommended method for correcting for conditional heteroskedasticity.
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