In the book Investments (Bodie, Kane, Marcus), in chapter 8, the authors discuss index models (page 247) and, in its context, systematic risk. The authors state, without explanation, that the market factor m of the unanticipated part of the realized return will have a mean of zero because, over time, "surprises will average out to zero".
I am unable to understand how the surprises would average out to zero. I believe my confusion can be understood through these questions:
- The statement implies that, when looked at over a long time horizon, firms come close to accurate predictions of expected return. However, it has been widely claimed that this is not the case. So how can we reconcile these two facts?
- Considering the above question, how can any macroeconomic variable reasonably proxy for unexpected developments in the economy?
- Could you please also show how the variance of the market factor can be estimated?
To give you an understanding of my background, I am an undergraduate enrolled in an introductory investments course. As such, my understanding is limited, and I would appreciate it very much if you could point me to other resources that might help me tackle my skepticism for security analysis and understand this concept more thoroughly.
Thanks for your time! I look forward to reading your answer.