Topic 7. AlternativeAssetPricingModels.pptx

Topic 7. AlternativeAssetPricingModels.pptx - BX2031:03...

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BX2031:03 Personal Portfolio Management Lecture Seven – Alternative Asset Pricing Models 1
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Learning objectives After completion of this chapter you should be able to: describe the alternative asset pricing models to the CAPM understand the specific asset pricing models, particularly: the arbitrage pricing theory (APT) the consumption CAPM (CCAPM) the Fama–French three-factor model and international asset pricing models understand the importance and relevance of the assumptions underlying these models discuss the empirical evidence of the alternative models compare the various models and understand their relative strengths and weaknesses apply these models in pricing risky assets. 2
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Chapter outline 1 Introduction 2 Consumption CAPM 3 Arbitrage Pricing Theory 4 Fama and French 5 International Asset Pricing Models 6 Summary 3
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1 Introduction This chapter provides a discussion of a number of alternative asset pricing models to the CAPM. The CAPM provides a useful base model for comparative purposes in that the model assumes a return-generating process consisting of a single factor. The models discussed are: CCAPM APT Fama and French the ICAPM models. 4
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2 Consumption CAPM The consumption capital asset pricing model (CCAPM) was developed by Rubinstein (1978). CCAPM defines the expected return of a portfolio as a linear function of the growth rate in consumption. E(R i ) = E(R Z ) + i c E(R Z ) = the return on a portfolio with zero consumption beta. i = cov ic / 2 c and is a measure of the relationship between portfolio i and the growth rate in aggregate consumption (c). c = the premium for consumption risk. 5
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2 Consumption CAPM Example: An asset has a consumption beta of 0.6. The expected return on an asset with a consumption beta of zero is 5% and the market price of consumption risk is 10%. Given this information, the expected return for this asset can be calculated as: E(Ri) = 0.05 + (0.6 x 0.10) = 0.11 or 11.0%. 6
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3 Arbitrage pricing theory APT motivation: overcome shortcomings of CAPM less restrictive assumptions of CAPM APT is empirically testable. APT is based on the law of one price.
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