Section 12 - ECON 136: Financial Economics Section 12 (Nov...

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ECON 136: Financial Economics Section 12 (Nov 20th) Xing Huang 1 Economics Department, UC Berkeley 1 Testing CAPM 1.1 Review Alpha CAPM can be tested by estimating the time series regression: R i;t ± R f;t = i + ± i ( R M;t ± R f;t ) + " i;t Here i is the estimated abnormal return on asset i that is not due to its risk, which is captured by ± i . CAPM predicts that i = 0 for all assets. Anomalies There are four well-documented asset pricing anomalies. These e/ects are anomalous in that the CAPM prediction that a test of the time-series regression R i;t ± R f;t = i + ± i ( R M;t ± R f;t ) + " i;t will show i = 0 a. Value E/ect: Value stocks (those with high book value-to-market value ratios) tend to have higher expected returns than the CAPM prediction, and growth stocks (those with low book- to market ratios) have lower expected returns than the CAPM prediction. In an empirical test of CAPM, a portfolio of that buys value stocks and short sells growth stocks has & > 0 (this alpha is b. Size E/ect: Small stocks (those with low market capitalization) tend to have higher ex- pected returns than the CAPM prediction, and large stocks (those with high market capitalization) tend to have lower expected returns than the CAPM prediction. In an empirical test of CAPM, a portfolio that buys small stocks and short sells large stocks has & > 0 . c. Momentum E/ect: Momentum stocks (those that have done well in the past year) have higher expected returns than the CAPM prediction, and recent looser stocks (those that have done poorly in the past year) have lower expected returns than the CAPM prediction. In an empirical test of CAPM, a portfolio that buys recent winner stocks and shorts recent looser stocks has & > 0 . d. Reversal E/ect:
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This note was uploaded on 01/25/2010 for the course ECON 136 taught by Professor Szeidl during the Fall '08 term at University of California, Berkeley.

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Section 12 - ECON 136: Financial Economics Section 12 (Nov...

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