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FIN460-Papanikolaou
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Introduction
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Who cares?
The CAPM is the most often used model for figuring out the appropriate
compensation for risk.
It is widely used in
a) Corporate Project Valuation
b) Portfolio Management
c) Evaluating Portfolio Managers
d) Cost-of-capital determination
, The failure of the CAPM implies that the market portfolio is not efficient.
, To understand what portfolio is efficient, you need to understand how it
fails.
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If the CAPM is true, then all securities should lie in the SML.
E(ri ) = r f + i [E(rm ) r f ]
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E(Ri,t r f ) = 0 + 1 i + ui
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0
1
R2
6.01%
0.17%
2%
Standard Error
t-stat
1.8%
1.7%
3.5
0.1
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SML
Historical Return
Forecasted Return
0.1 0.2 0.3 0.4
0.5
0.6
QCOM
VRTS
ORCL
NT
AA
AOL
CMCSK
HD
DOW
SUNW
EMC
AMGN
0.0
IP
-0.1
BK
BAC
ONE
UN
SWY WB
-0.3
LMT MO
WMI
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
2.6
Beta
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To test the CAPM one needs to specify what the market portfolio
is.
a) Only 1/3 non governmental tangible assets are owned by the
corporate sector.
b) Among the corporate assets, only 1/3 is financed by equity
c) What about intangible assets, like human capital?
d) International markets?
Measurement error in
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-4
-3
-2
-1
Second Year:
-5
-4
-3
-2
-1
-4
-3
-2
-1
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predicted by the traditional form of the asset pricing model. At the same time, the low-
BJS: Results
risk securities earned more than the amount predicted by the model.
Table 2
Summary of Statistics for Time Series Tests, Entire Period (January, 1931-December, 1965)
(Sample Size for Each Regression =420)
Portfolio Number
Item*
"
" 10
t (" )
,R
M)
r(R
10
RM
1.5614
1.3838
1.2483
1.1625
1.0572
0.9229
0.8531
0.7534
0.6291
0.4992
1.0000
0.0593
0.0462
0.0812
0.1968
0.2012
0.7878
0.7050
1.1837
2.3126
1.8684
!!0.9625
0.9875
0.9882
0.9914
0.9833
0.9851
0.9793
0.9560
0.8981
0.0366
0.9915
0.1294
0.1041
0.0444
0.0992
" (e )
R
"
! 0.0393
! 0.0213
0.0197
0.0173
0.0137
0.0124
0.0152
0.0133
0.0139
0.0172
0.0218
0.0177
0.0171
0.0163
0.0145
0.0137
0.0126
0.0115
0.0109
0.0091
0.0142
0.1445
0.1248
0.1126
0.1045
0.0950
0.0836
0.0772
0.0685
0.0586
0.0495
0.0891
! monthly excess returns, " = standard deviation of the monthly excess returns, r = correlation
* R M = average
!
coefficient.
!
!
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BJS: Results
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MKCap(m$)
NYSE
10
9
8
7
6
5
4
3
2
1
511,391
10,486
4,428
2,237
1,387
889
534
353
198
95
172
172
172
172
172
172
172
172
172
172
FIN460-Papanikolaou
# of Stocks
AMEX
NASDAQ
5
3
5
5
5
11
15
32
73
412
80
81
136
166
217
254
251
400
551
1,399
Total
257
256
313
343
394
437
438
604
796
1,983
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14
12
10
0
1
10
MKCAP Decile
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Market Beta
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Market Beta
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They find that the relation between average returns and market
within size decile is generally negative.
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Sort
Lo
6.77
(2.22)
19.98
2
8.01
(2.13)
19.16
(t)
MKT
(t)
R2 (%)
-1.01
(0.74)
1.01
(0.02)
89.80
0.42
(0.60)
0.98
(0.02)
92.74
E(Ri ) r f
-0.23
(0.73)
1.06
(0.04)
89.94
1.38
(0.78)
0.98
(0.03)
88.02
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1.13
(0.87)
1.06
(0.04)
87.23
0.92
(1.04)
1.13
(0.06)
83.44
2.46
(1.14)
1.16
(0.07)
80.80
9
12.12
(2.95)
26.48
Hi
13.17
(3.62)
32.49
Hi-Lo
6.40
(2.57)
23.10
2.43
(1.34)
1.25
(0.05)
79.38
1.97
(1.84)
1.45
(0.10)
70.35
2.98
(2.30)
0.44
(0.11)
12.89
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Sort
Lo
3.95
(2.67)
18.01
2
5.59
(2.42)
16.35
(t)
MKT
(t)
R2 (%)
-2.07
(1.05)
1.10
(0.02)
86.02
-0.04
(0.73)
1.03
(0.02)
91.34
E(Ri ) r f
0.95
(0.95)
0.97
(0.03)
85.63
1.38
(1.01)
0.89
(0.03)
81.92
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2.38
(0.92)
0.90
(0.03)
83.31
3.63
(1.10)
0.86
(0.03)
76.58
4.05
(1.12)
0.84
(0.03)
75.20
9
9.64
(2.37)
16.01
Hi
11.11
(2.73)
18.46
Hi-Lo
7.16
(2.28)
15.39
4.66
(1.23)
0.91
(0.04)
74.27
5.71
(1.71)
0.99
(0.05)
65.82
7.78
(2.44)
-0.11
(0.06)
1.07
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16
14
12
Large Value
10
8
Large Growth
6
Small Growth
4
2
0.7
0.8
0.9
1.1
1.2
1.3
1.4
1.5
1.6
Market beta
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Explanations?
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Related patterns
Value and size effects are only the tip of the iceberg.
The literature has documented a number of other patterns:
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Short-Term Momentum
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Short-Term Momentum
Form portfolios of stocks selected on their past return over the last 12 months.
We will rebalance these portfolios every month.
Lo
0.31
(3.70)
33.24
Wi
15.37
(2.52)
22.64
Wi-Lo
15.07
(2.94)
26.44
(t)
MKT
(t)
R2 (%)
-11.52
(1.65)
1.53
(0.08)
74.95
-5.08
(1.31)
1.33
(0.07)
78.61
7.48
(1.33)
1.02
(0.06)
71.90
19.01
(2.44)
-0.51
(0.13)
13.05
Sort
E(Ri ) r f
-3.91
(1.12)
1.17
(0.06)
82.24
-1.77
(0.94)
1.10
(0.04)
85.01
-1.18
(0.79)
1.03
(0.04)
87.30
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-0.39
(0.66)
1.03
(0.02)
90.93
1.09
(0.70)
0.98
(0.02)
89.64
3.05
(0.70)
0.94
(0.02)
88.34
3.97
(0.81)
0.97
(0.03)
85.09
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Short-Term Momentum
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Short-Term Momentum
, Commodities
, Currencies
, Sovereign bonds
, Industry indices
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Post-Earnings
Announcement
Drift
VICTOR L. BERNARD AND JACOB K. THOMAS
10
......................................................................................................
post-announcement period
pre-announcement period
i SUE
,ideciles
FIG. 2.-Cumulative abnormal returns (CARs) for SUE portfolios: all announcements.
FIN460-Papanikolaou
CAPM and empirical evidence
Earnings announcements are assigned to deciles based on standing of standardized unex-
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(%)
Lo
-0.19
(-0.04)
36.38
2
2.52
(0.69)
24.55
9
4.43
(1.77)
16.75
Hi
6.26
(2.27)
18.53
Hi-Lo
6.46
(1.59)
27.97
(%)
(t)
MKT
(t)
R2 (%)
-7.81
(-2.17)
1.52
(7.31)
56.79
-3.46
(-2.01)
1.20
(9.51)
76.89
0.18
(0.10)
1.10
(8.91)
75.47
0.01
(0.01)
0.88
(22.69)
90.14
1.69
(1.36)
0.91
(12.63)
79.02
9.50
(2.42)
-0.61
(-2.52)
15.32
Sort
E(R) r f (%)
-0.05
(-0.02)
1.04
(7.79)
70.07
FIN460-Papanikolaou
2.28
(1.23)
0.89
(8.58)
69.54
2.51
(2.54)
0.89
(13.34)
85.77
-0.14
(-0.14)
0.91
(13.69)
84.62
2.11
(2.20)
0.90
(14.89)
88.72
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Assets
Minimum Var Frontier
CML
MVE Portfolio
BMVE Combinations
C
B
Expected Return
0.1
0.09
Market Portfolio
A
0.08
0.07
0.06
0.05
0.04
RiskFree Asset
0.03
0
0.05
0.1
0.15
0.2
Return Standard Deviation
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0.25
0.3
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Roll points out that, since the market portfolio is not identifiable,
we cannot really test the CAPM.
, The market proxies that we use do not include
a) Real Estate
b) Human Capital
, Roll instead advocates the use of the APT, which we will see next.
However, perhaps the usefulness of the Roll critique is in
reminding us that if we find that the CAPM tests do not hold, then
the so-called market (or really market proxy) is not MVE and,
unless you have very special reasons for doing so, you should not
hold the market proxy!
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