Beruflich Dokumente
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Lecture 5
1-1
Chapter 9
9-2
Capital Market Theory
9-3
Capital Market Theory Assumptions
All investors:
Use the same information to generate an efficient
frontier
Have the same one-period time horizon
Can borrow or lend money at the risk-free rate of
return
No transaction costs, no personal income
taxes, no inflation
No single investor can affect the price of a
stock
Capital markets are in equilibrium
9-4
Borrowing and Lending Possibilities
9-5
Borrowing Possibilities
9-6
The New Efficient Set
9-7
Risk-Free Lending
Riskless assets can
L be combined with
any portfolio in the
B
efficient set AB
E(R) T Z implies lending
Z X Set of portfolios on
RF line RF to T
A dominates all
portfolios below it
Risk
9-8
Portfolio Choice
9-9
Market Portfolio
Market Portfolio
All investors hold the same optimal portfolio
of risky assets
The optimal portfolio is at the highest point
of tangency between RF and the efficient
frontier
The portfolio of all risky assets is the
optimal risky portfolio
Called the market portfolio
9-10
Characteristics of the Market
Portfolio
All risky assets must be in portfolio, so
it is completely diversified
Includes only systematic risk
All securities included in proportion to
their market value
Unobservable but proxied by S&P 500
Contains worldwide assets
Financial and real assets
9-11
Capital Market Line
Efficient portfolios consists of Risky Assets
and Risk Free Assets
All possible combination of Risky Assets
and Risk Free Assets are on the CML.
In equilibrium, all investors will end up
with a portfolio somewhere on the CML
based on their risk tolerance i.e. based on
how much they lend or borrow
9-12
Capital Market Line
If investors were to
L invest in risky assets,
they must be
M compensated with a
E(RM) risk premium which is
x
x x =E(RM) RF
RF
Slope = x/y which
y means how much
additional return
required for every
M increment of RISK
Risk =[E(RM) - RF]/M
9-13
Capital Market Line (CML)
9-
14
The Separation Theorem
Investors use their preferences (reflected
in an indifference curve) to determine
their optimal portfolio
Separation Theorem:
The investment decision, which risky portfolio
to hold, is separate from the financing decision
Allocation between risk-free asset and risky
portfolio separate from choice of risky portfolio
9-15
Separation Theorem
All investors
Invest in the same portfolio
Attain any point on the straight line RF-T-L
by by either borrowing or lending at the
rate RF, depending on their preferences
Risky portfolios are not tailored to each
individuals taste
9-16
Capital Asset Pricing Model
9-17
Security Market Line
9-18
Security Market Line
E(Ri ) RF i E(RM ) RF
9-19
Security Market Line
9-20
Security Market Line
9-21
CAPMs Expected
Return-Beta Relationship
Required rate of return on an asset (ki)
is composed of
risk-free rate (RF)
risk premium (i [ E(RM) - RF ])
Market risk premium adjusted for specific
security
ki = RF +i [ E(RM) - RF ]
The greater the systematic risk, the greater
the required return
9-22
Example on CAPM
9-23
Example on CAPM
ki = RF +i [ E(RM) - RF ]
K for IBM
= 0.05 + 1.15 (0.12-0.05)
= 0.1305
= 13.05%
9-24
Estimating the SML
9-25
Estimating Beta
Market model
Relates the return on each stock to the return on the
9-26
How Accurate Are Beta
Estimates?
Betas change with a companys
situation
Not stationary over time
Estimating a future beta
May differ from the historical beta
RM represents the total of all
marketable assets in the economy
Approximated with a stock market index
Approximates return on all common stocks
9-27
How Accurate Are Beta
Estimates?
No one correct number of observations
and time periods for calculating beta
The regression calculations of the true
and from the characteristic line are
subject to estimation error
Portfolio betas more reliable than
individual security betas
9-28
SML vs CML
Risk Measurement
CML uses standard deviation as the measure of risk
portfolios
Portfolio Vs Stock
CML determines risk or return for efficient portfolios
9-29
Arbitrage Pricing Theory
9-30
Arbitrage Pricing Theory
A general theory of asset pricing that
holds that the expected return of a
financial asset can be modeled as a linear
function of various macro-economic
factors where sensitivity to changes in
each factor is represented by a factor-
specific beta coefficient.
The model-derived rate of return will then
be used to price the asset correctly.
9-31
Arbitrage Pricing Theory
Based on the Law of One Price
Two otherwise identical assets cannot sell
at different prices
Equilibrium prices adjust to eliminate all
arbitrage opportunities
Unlike CAPM, APT does not assume
single-period investment horizon, normal
distribution of expected returns, riskless
borrowing or lending, mean-variance
decisions
9-32
Factors
9-33
APT Model
9-34
Problems with APT
9-35
Chapter 12
12-36
Efficient Markets
12-37
Conditions for an Efficient Market
12-39
Market Efficiency Forms
12-40
Weak Form
12-41
Semistrong Form
12-42
Semistrong Form Evidence
12-43
Strong Form
12-44
How to test for market
efficiency?
12-45
Evidence on Market Efficiency
Keys:
Consistency of returns in excess of risk
Random short-lived inefficiency do not
constitute inefficient market. (maybe you
are just lucky!)
Economically efficient markets
Assets are priced so that investors cannot
exploit any discrepancies and earn unusual
returns
Transaction costs is taken into consideration
when performing test on market efficiency.
12-46
Example of Economically Efficient Market
12-47
Weak Form Evidence
Event studies
Empirical analysis of stock price behavior
surrounding a particular event
Tests of the speed of price adjustments to
publicly available information.
Examine company unique returns
The residual error between the securitys actual
return and expected return (given by the index
model)
12-49
Semistrong Form Evidence
Stock splits Initial public
Implications of split offerings
reflected in price Only issues purchased
immediately following at offer price yield
the announcement abnormal returns
Accounting changes Announcements and
Quick reaction to real news
change in value Little impact on price
after release
12-50
Strong Form Evidence
12-51
Implications of Efficient Market Hypothesis
12-52
Market Anomalies
12
-
Market Anomalies Earnings
Announcements
Earnings announcements affect stock prices.
Adjustment occurs before announcement but
significant amount after the announcement
Contrary to efficient market because the lag should
not exist
How much of the earning announcement has been
anticipated by the market?
How much of the announcement is surprise
How quickly is the surprise reflected in the price?
If there is a lag in the price, investor has a chance
to make extra return by acting quickly on those
surprises
Research results showed there is a lag in
adjustment in stock price on earning surprises.
12-54
Market Anomalies P/E
Low P/E ratio stocks tend to outperform
high P/E ratio stocks
Low P/E stocks generally have higher risk-
adjusted returns
But P/E ratio is public information
12-55
Market Anomalies Size Effect
Size effect
Tendency for small firms to have higher
risk-adjusted returns than large firms
What is definition of small?
Studies showed a significance of the size
effect occurred during the first 5 trading
days of January.
12-56
Market Anomalies January Effect
Strong performance in January by small
company stocks has become known as
the January effect.
January effect
Several studies have suggested that
seasonality exists in the stock market.
Tendency for small firm stock returns to be
higher in January
Why ?
12-57
Market Anomalies Value Line
Ranking System
Value Line is famous investment advisory
service in the USA.
Value Line Ranking System
Advisory service that ranks 1700 stocks in
12-58
Behavioral Finance
12-59
Behavioral Finance
EMH assume that individual act
rationally and consider all information
when making decision.
However, we know that human being
tend to get emotional when making
decision
BF says that investors often make
systematic mistakes when processing
market info due to emotion.
12-60
Behavioral Finance
Are there systematic deviations from
the norms of rationality?
How do human beings make decisions?
Distortion throughout the process of
decision-making
In making predictions, perceiving the
environment
Marriage of psychology and finance
BF studies market anomalies are
exceptions that appear to be contrary
to market efficiency
12-61
Conclusions About Market Efficiency
Market is efficient:
Proven by many researches using different
methods.
Even more efficient now with internet.
Market anomalies cannot be explained
satisfactorily and therefore not conclusive.
Markets very efficient but not totally
Most mutual funds cannot beat the market.
To outperform the market, fundamental
analysis beyond the norm must be done.
12-62
Conclusions About Market Efficiency
12-63
The End
2-64
Tutorial Questions
Chapter 9
Questions: 1, 3, 4, 5, 8, 9, 10
Problems: 4
Chapter 12
Questions: 1, 2, 3, 4, 8
2-65