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# slides12 - 12 Additional topics In these slides we briefly...

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Unformatted text preview: 12. Additional topics In these slides we briefly discuss • Arbitrage pricing theory (APT) • Market efficency • Behavioral finance APT • In the CAPM, expected returns depend upon just a single factor, the asset’s exposure to market risk . • But in fact, there may be several factors driving returns, and different assets may respond to changes in those variables in different ways. • Possible factors (other than market returns) that have been suggested in the literature include: – inflation – GDP growth – short-term interest rates – spread between short and long-term bonds – energy prices 2 APT — continued The arbitrage pricing model (APT) , suggested by Stephen Ross, looks similar to the CAPM, but allows for several factors. The statistical model for asset returns put forward by the APT is R A = R f + n summationdisplay i =1 b Ai λ i + n summationdisplay i =1 b Ai F i + epsilon1 where R A = the asset’s return F i = the i th factor b Ai = Asset A’s exposure to risk associated with the F i (also known as the factor loading ) λ i = the risk premium associated with F i Notes: • Factors should be normalized to mean zero. • The CAPM can be interpreted as a special case of this model (with only a single factor). 3 APT — continued As with the CAPM, the factor loadings , b Ai , are unknown, but can be estimated by linear regression . But, whereas the CAPM tells us • the factor (market excess returns) • the risk premium ( E ( r M )- r F ) APT tells us neither. The risk premia can be estimated from data. Deciding what factors to use is more or less a matter of testing different possibilities to see what seems to give good results. 4 Example — APT We would like to use a two factor APT model to estimate the expected return for Eagle Aerospace Corp. • Suppose that the risk premia are λ 1 = 3% and λ 2 = 4% . • Based on a regression analysis for Eagle’s stock returns and the two factors, we estimate that the factor loadings are β 1 = 2 and β 2 = 1 . 5 ....
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## This note was uploaded on 03/31/2008 for the course FNCE 3010 taught by Professor Donchez,ro during the Fall '07 term at Colorado.

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slides12 - 12 Additional topics In these slides we briefly...

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