The Level of Detail in an Economic Model

question 101

Multiple Choice

The level of detail in an economic model

• A) is as close as possible to the level of detail in reality
• B) depends on the purpose of the model
• C) is as complex as possible
• D) is the same regardless of the purpose of the model
• E) is as complex as possible to accomplish its purpose

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Definitions:

CAPM

The Capital Asset Pricing Model, a theory that describes the relationship between the expected return and risk of investing in a security.

Risk-Free Rate

The theoretical rate of return of an investment with zero risk, typically represented by the yield on government securities like U.S. Treasury bonds.

Equity Premium Puzzle

The observed phenomenon where stocks have historically outperformed government bonds by a greater margin than can be explained by traditional financial theories.

Survivorship Bias

A bias that occurs when analyzing performance or characteristics by overlooking failures or non-survivors, leading to overly optimistic or skewed outcomes.