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THE CAPITAL ASSET PRICING MODEL THEOORY AND EVIDENCE CAPM is the first proposed by Sharpe(1964) and Markowitz, Sharpe, Lintner and mossin are researchers credited with its development. CAPM is the first proposed by Sharpe(1964) and Markowitz, Sharpe, Lintner and mossin are researchers credited with its development.
BÀI THUYẾT TRÌNH NHĨM:5-2 LỚP : TCDN NGÀY GVHD : TS.Trần Thị Hải Lý HVTH: Võ Thị Thúy Diễm Trần Thị Trang Phan Thị Thanh Kiều Trần Thân Bích Hợp Trương Phú Trí THE CAPITAL ASSET PRICING MODE THEOORY AND EVIDENCE CAPM is the first proposed by Sharpe(1964) and Markowitz, Sharpe, Lintner and mossin are researchers credited with its development THE LOGIC OF CAPM You have millions of Dollars and you want to make an investment THE LOGIC OF CAPM You have choices Bank Business No risk Medium risk Earn 2% Earn more 2% THE LOGIC OF CAPM How you caculate your required rate of Return? CAPM is the model that predicts the relationship between the risk and expected returns on risky assets THE LOGIC OF CAPM Return = Time value of money + Risk An investor needs a return on the time value of his/her money and the risk involved THE LOGIC OF CAPM CAPM says that the risk of stock should be measured relative to a comprehensive” maket portfolio” that in principle can include not just traded financial assets, but also consumers durables, real estate and human capital THE LOGIC OF CAPM Is it that legitimate to limit futher the market portfolio to U.S common stocks or should the market be expanded to include bons, and other financial assets? Whether the model’s problem reflect weakness in the theory or in its emperical implemention, the failure of the CAPM in emperical test implies that most applications of the model are invalid Logic of CAPM CAPM builds on the model of portfolio choice developed by Harry Markowitz(1959) In Markowitz’s model, an investor selects a portfolio at time t-1 that produces a stochstic at t Recent Tests Basu’s (1977) Banz (1981) Bhandari (1988) Statman (1980),Rosenberg, Reid and Lanstein (1985) Fama and French (1992) Fama and French (1992) Using the cross-section regression approach Confirm that size, earnings-price, debt-equity and book-to-market ratios add to the explanation of expected stock returns provided by market beta the relation between average return and beta for common stocks is even flatter after the sample periods used in the early empirical work on the CAPM Debondt & Thaler (1985) finds a reversal in longterm returns, stock with slow longterm-past return tend to have higher future return Jegadeesh and Titman (1993) finds that short term returns tend to continue; stock with higher returns in the previous 12 months tends to have higher future returns (momentum) Others have shown that a firm’s average stock return is related to its size, BE/ME, E/P, C/P & past sales growth (Banz (1981); Basu (1983), Rosenberg Reid & Lanstein (1985); Lakonoshok, Shleifer and Vishny (1994)) Explanations: Irrational Pricing or Risk Two stories emerge for empirical failures of the CAPM One side are the behavioralists Low P/E, B/V: associated with growth firms -> higher return Size of firms: Low market value -> higher return The second story is based on may unrealistic assumption Care not only about mean and variance but also future investment opportunities ICAPM VS CAPM Merton (1973) intertemporal capital asset pricing model (ICAPM) is a natural extension of the CAPM CAPM ICAPM Investor care only about the wealth their portfolio produces at the end of the current period -Concerned not only with their end-ofperiod payoff, but also with the opportunities they will have to consume or invest the payoff - Consider how their wealth at t might vary with future state variables Prefer high expected return and low return variance - The same - Also concerned with the covariances of portfolio return with state variables - Optimal portfolios are “multifactor efficient” Three-Factor Model Fama and French (1993,1996) propose a three- factor model for expected returns SMBt: Small minus big: difference between the returns on diversified portfolios of small and big stocks HMLt: high minus low: difference between the returns on diversified portfolios of high and low B/M stocks The 3-factor model explains the pattern in returns that is observed when portfolios are formed on E/P, C/P and sales growth Low E/P, low C/P, and high sales growth are typical of strong firms that have ( ) slopes on HML (similar to the slopes for low BE/ME) => low expected returns High E/P, high C/P, and slow sales growth are typical of weak firms that have (+) slopes on HLM (similar to the slopes for high BE/ME) => high expexted returns The 3-factor model captures the reversal of long term returns Stock with low long-term past returns (loser) tend to have (+) SMB and HML slopes (look like small and relative distressed stocks) and higher future average return; Stock with high long-term past returns (winners) tend to have ( ) SMB and HML slopes (look like big and strong stocks) and higher future average return But, it can not explain continuation of short-term returns: Stocks with low short-term past returns tends to have slopes (+) in HLM (like losers) Momentum factor and Cash flows factor Carhart (1997), one response is to add a momentum factor (the difference between the returns on diversified portfolios of short-term winners and losers) to the three-factor model Frankel and Lee (1998), Dechow, Hutton and Sloan (1999), Piotroski (2000), stock with higher expected cash flows have higher average returns that are not captured by the three-factor model or the CAPM The Market Proxy Problem - The problem is that the market portfolio at the heart of the model is theoretically and empirically elusive It is not theoretically clear which assets (for example, human capital) can legitimately be excluded from the market portfolio, and data availability substantially limits the assets that are included - Tests of the CAPM are forced to use proxies for the market portfolio, in effect testing whether the proxies are on the minimum variance frontier - If we can find a market proxy that is on the minimum variance frontier, it can be used to describe differences in expected returns - Researchers have not uncovered a reasonable market proxy that is close to the minimum variance frontier If researchers are onstrained to reasonable proxies, we doubt they ever will The positive relation between beta and average return predicted by the CAPM is notably absent We judge it unlikely that alternative proxies for the market portfolio will produce betas and a market premium that can explain the average returns on these portfolios The contradictions of the CAPM observed when such proxies are used in tests of the model show up as bad estimates of expected returns in applications; for example, estimates of the cost of equity capital that are too low (relative to historical average returns) for small stocks and for stocks with high book-to-market equity ratios In short, if a market proxy does not work in tests of the CAPM, it does not work in applications Conclusions As a result, CAPM estimates of the cost of equity for high beta stocks are too high (relative to historical average returns) and estimates for low beta stocks are too low (Friend and Blume, 1970) Similarly, if the high average returns on value stocks (with high book-to-market ratios) imply high expected returns, CAPM cost of equity estimates for such stocks are too low The CAPM is also often used to measure the performance of mutual funds and other managed portfolios .. .THE CAPITAL ASSET PRICING MODE THEOORY AND EVIDENCE CAPM is the first proposed by Sharpe(1964) and Markowitz, Sharpe, Lintner and mossin are researchers credited with its development THE. .. model or the CAPM The Market Proxy Problem - The problem is that the market portfolio at the heart of the model is theoretically and empirically elusive It is not theoretically clear which assets... in the relation between expected return and market beta The times-series means of the monthly slopes and intercepts, along with the standard errors of the means, are then used to test whether the