A risk manager at Firm SPC is testing a portfolio for heteroskedasticity using the White test. The portfolio is modeled as follows:

$Y_i = a + \beta X_{1i} + \epsilon_i$

The residuals are computed as follows:

$\hat{\epsilon}_i = Y_i - \hat{\alpha} - \hat{\beta}X_{1i}$

Which of the following correctly depicts the second step in the White test for the portfolio?

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A

$\hat{\epsilon}_i^2 = \gamma_0 + \gamma_1 X_{1i} + \gamma_2 X_{1i}^2 + \eta_i$

B

$\hat{\epsilon}_i^2 = \gamma_1 X_{1i} + \gamma_2 X_{1i}^2 + \eta_i$

C

$\hat{\epsilon}_i^2 = \gamma_0 + \gamma_1 X_{1i} + \eta_i$

D

$\hat{\epsilon}_i^2 = \gamma_0 + \gamma_1 X_{1i}^2 + \eta_i$

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Financial Risk Manager Part 1