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Week 7: Asset Pricing Models (CAPM (Capital Asset Pricing Model) (all…
Week 7: Asset Pricing Models
CAPM (Capital Asset Pricing Model)
relationship between risk and expected return
evaluating
possible investments
for companies (benchmark)
all investors hold the
market portfolio
relevant risk
: contribution of an asset to the risk of the market portfolio
systematic risk
is market risk
Tangency portfolio of the CML
M is the
market portfolio
, contains all risky assets (stocks, bonds, real estate, etc) held according to their relative market value
Stock market index
is used as an approximation
From CML to CAPM
Investor hold an
efficient portfolio
(whose return is given by the CML)
Individual securities
will typically be
inefficient
(
below CML
)
Security Market Line (SML)
: relationship between individual asset returns and its
relevant risk
pricing example: page 19
higher return => lower price => undervalued (alpha > 0 => good)
alpha =
expected return (actual data) - expected return (SML)
alpha is
abnormal return
Multi- factor Models
company
size
book value
liquidity factor models
spread (bid and ask) => higher the spread => less liquid
Arbitrage Pricing Theory (APT)
arbitrage
efficient markets
zero investment
example (p.44)
CAPM and SML
CAPM only prices non- diversify risk
SML deals with systematic risk
Limitations of CAPM (p.23)
works with expected returns not the actual returns
CAPM and the index model
(p.24)
Adjusted betas (p.30)
A critique on the CAPM
(p.32)