1、Foundations of Financial Analysis and InvestmentsLecture 3:Capital Asset Pricing Model(CAPM)1PPT课件Todays lecture1.Brief revision:Lecture 22.Mean-variance optimization with unlimited borrowing and lending at a risk-free rate3.MPT and CAPM:Preliminary remarks 4.The Capital Asset Pricing Model(CAPM)5.F
2、irst considerations about the limitations of CAPM2PPT课件The portfolio consists of two risky assets D(debt)and E(equity)Their weights in the portfolio are We construct risky portfolios varying to provide the lowest possible risk for any given level of expected returnE(rp)=wD E(rD)+wEE(rE)x xD D and x
3、xE E(xD+xE=1;xD 0,xE 0)x xD D and x xE E222222Cov,pDDEEDEDEwww wrrCov(rD,rE)=DEDESuccess of diversification depends on the correlation coefficientBodie et al.2014,Ch.71.Brief revision:Lecture 23PPT课件DebtEquityExpected return E(r)8%13%Standard deviation 12%20%Bodie et al.(2014),Table 7.1,p.208Bodie e
4、t al.(2014),Table 7.3,p.211ABBodie et al.(2014),p.2141.Brief revision:Lecture 24PPT课件DebtEquityExpected return E(r)8%13%Standard deviation 12%20%Bodie et al.(2014),Table 7.1,p.208Bodie et al.(2014),Table 7.3,p.211When DE=-1,DEDDEww1When DE=0,1.Brief revision:Lecture 25PPT课件1.Brief revision:Lecture 2
5、Source:Bodie et al.2014:p.2206PPT课件Diversifiable(non systematic)risk vs undiversifiable(systematic)risk 1.Brief revision:Lecture 2Bodie et al.(2014),p.2077PPT课件How does diversification matter?8PPT课件SponsorsTrusteesThe Investment Management FirmInvestment consultantsthe Tampa firefighters and police
6、officers pension fundCity of Tampa,FloridaHarold J.Bowen III How does diversification matter?Source:http:/ As for being diversified,which is the mantra of nearly all institutional money managers and consultants,the Tampa fund isnt.The funds assets are concentrated in a relatively small number of sto
7、cks and fixed-income investments.In short,the Tampa pension fund pretty much breaks all the conventional rules of fund management.9PPT课件2.Mean-variance optimization with unlimited borrowing and lending at a risk-free rate10PPT课件Unlimited borrowing and lending at a risk-free rate:-Riskless asset is a
8、n asset with a certain return for the given time horizon.-For example:US Treasury bonds that automatically adjust for inflation(TIPS:Treasury inflation protected securities)or short term US Treasury bills(US T-bills)-Standard deviation of the return:=0 2.Mean-variance optimization with unlimited bor
9、rowing and lending at a risk-free rate11PPT课件If you invest in asset H and riskless asset:xH and xf=1-xHErErp p=(1-xH)Rf+xH RH=R Rf f+x+xH H(Er(ErH H-R Rf f)p=(1-xH)2 f+xH2 H2+2xH(1-xH)fH f HAs f=0,we obtain:p p=x=xH H H H2.Mean-variance optimization with unlimited borrowing and lending at a risk-fre
10、e rateSource:Perold 200412PPT课件Combining equations for portfolio return and risk,we obtain:ErH-RfErp=Rf +p H2.Mean-variance optimization with unlimited borrowing and lending at a risk-free rateSource:Perold 200413PPT课件 ErH-Rf HThe slope:Sharpe ratio(Er(ErH H-R-Rf f)Risk premium2.Mean-variance optimi
11、zation with unlimited borrowing and lending at a risk-free rateSource:Perold 200414PPT课件Sharpe ratio of asset H:(12%-5%)/40%=0.175Important:all combinations of asset H with risk-free borrowing and lending have the same Sharpe ratio:it is the slope of a straight lineSharpe ratio of asset M:(10%-5%)/2
12、0%=0.252.Mean-variance optimization with unlimited borrowing and lending at a risk-free rateSource:Perold 200415PPT课件Use of Sharpe ratio in practice:Shape ratio is used to measure the performance of a portfolioAdvantage:the risk adjusted performance measurement2.Mean-variance optimization with unlim
13、ited borrowing and lending at a risk-free rate16PPT课件Sharpe ratio of H 1,it indicates that the securitys price will be more volatile than the marketExample:a beta equals to 1.3 means that the security is 30%more volatile than the market31PPT课件Use of beta in practice:Beta as a measure of risk of a mu
14、tual fundExample:The BlackRock Global Small Cap Fund(factsheet)Source:https:/ Capital Asset Pricing Model(CAPM)32PPT课件The security market line provides abenchmark for the evaluation of investment performance Asset plots above the SML offer a greater expected returns than indicated by the CAPM(underp
15、riced assets)Asset plots below the SML offer a lower expected returns than indicated by the CAPM(overpriced assets)4.The Capital Asset Pricing Model(CAPM)33PPT课件Example:Market return is expected to be 14%,the stock beta is 1.2,the T-bill rate is 6%.The expected return on the stock is:6+1.2(14 6)=15.
16、6%If you expect 17%return for the stock,the implied alpha is 1.4%4.The Capital Asset Pricing Model(CAPM)34PPT课件Implications of the CAPM:1.The expected return of a stock does not depend on its idiosyncratic risk2.In the CAPM,a stocks expected return does not depend on the growth rate of its expected
17、future cash flows3.Beta measures the risk of an asset that cannot be diversified away Overall riskof an asset=Systematic riskCompany specific risk+4.The Capital Asset Pricing Model(CAPM)35PPT课件 Implications of the CAPM for diversificationDiversification reduces risks but does not eliminate themThe t
18、ype of risk that diversification reduces is the company specific=idiosyncratic risk=a risk specific to each particular asset=it is not correlated across assetsWhen we increase a number of assets in a portfolio,we expect that on average the idiosyncratic risks cancel each other and that the actual re
19、turn gets closer to the expected return there is no reason to expect compensation for bearing this riskSystematic risk is common across assets you cannot reduce this risk through diversificationSources of systematic risk:the overall economy or financial markets risk-avers investors require compensat
20、ion for bearing this riskFullenkamp 20124.The Capital Asset Pricing Model(CAPM)36PPT课件Quick check:Are the following true or false?Explain.a.Stocks with a beta of zero offer an expected rate of return of zero.b.The CAPM implies that investors require a higher return to hold highly volatile securities
21、c.You can construct a portfolio with beta of 0.75 by investing 75%of the investment budget in T-bills and the remainder in the market portfolio.Source:Bodie et al.2014:3174.The Capital Asset Pricing Model(CAPM)37PPT课件Quick check:Which of the following factors reflect pure market risk for a given cor
22、poration?a.Increased short-term interest rates.b.Fire in the corporation warehousec.Increased insurance costsd.Death of the CEOe.Increased labour costs.Source:Bodie et al.2014:2354.The Capital Asset Pricing Model(CAPM)38PPT课件Main predictions of the CAPMAll investors-will always combine a risk free a
23、sset with the market portfolio-will have the same portfolio of risky assets(the market portfolio)-agree on the expected return and on the expected variance of the market portfolio and of every asset-agree on the market risk premium and on the beta of every asset-agree on the market portfolio being o
24、n the minimum variance frontier and being mean-variance efficient-expect returns from their investments according to the betas-Trading volume of financial markets will be very small4.The Capital Asset Pricing Model(CAPM)39PPT课件5.First considerations about the limitations of CAPM40PPT课件CAPM=equilibri
25、um model(“snapshot”of the market at one point in time)What is“market portfolio”?Indices,national vs.internationalRisk premiums depend on invesment climate and business cycleWarren Buffett:“Risk comes from not knowing what youre doing.”Does the fundamental cash flow analysis really not matter?CAPM ha
26、s not been confirmed empirically(next lecture)41PPT课件 doesnt explain the variance of returns:Basu(1977):earning-price-ratio effectBanz(1981):size effectBhandari(1988):high debt-equity-ratio effectStatman et al.(1980):book-to-market-ratio effectBenjamin Graham,the legendary investor:Beta is a more or
27、 less useful measure of past price fluctuations of common stocks.What bothers me is that authorities now equate the beta idea with the concept of risk.Price variability yes;risk no.Real investment risk is measured not by the percent that a stock may decline in price in relation to the general market
28、 in a given period,but the danger of a loss of quality and earning power through economic changes or deterioration of management.Is beta the real source of risk?5.First considerations about the limitations of CAPM42PPT课件Is CAPM just CRAP(completely redundant asset pricing)?Montier(2007):“Institution
29、al money managers dont think in terms of variance as a description of risk.Never yet have I met a long only investor who cares about up-side standard deviation;this gets lumped into return.”“An entire industry appears to have arisen obsessed with and.“Fama/French(2004):The CAPM,like Markowitz(1952,1
30、959)portfolio model on which it is built,is nevertheless a theoretical tour de force.We continue to teach the CAPM as an introduction to the fundamental concepts of portfolio theory and asset pricing,to be built on by more complicated models like Mertons(1973)ICAPM.But we also warn students that des
31、pite its seductive simplicity,the CAPMs empirical problems probably invalidate its use in applications.”5.First considerations about the limitations of CAPM43PPT课件ReferencesBodie,Kane and Markus(2014),Investments,McGrauw Hill,section 7.3 and chapter 9Perold,Andre(2004),The Capital Asset Pricing Model,Journal of Economic Perspectives 18(3),pp.773-806.44PPT课件
