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Unformatted text preview: incorrect ● (2) Difficult to judge whether CAPM is correct or incorrect ● (3) CAPM theory is incorrect, need an improved theory Multifactor CAPM ● Intuition for simple CAPM: – Return has systematic and unsystematic components ● R i – r f = α i + (r m – r f ) β i + residual i ● = α i + F 1 β i + residual i – Expected return depends only on sensitivity to source of systematic return F 1 (Security Market Line) ● E(r i ) = r f + ( E(r m ) – r f ) β i = λ + λ 1 β i Multifactor CAPM ● More generally – Return has systematic and unsystematic components ● R i – r f = α i + F 1 β 1i + F 2 β 2i + F 3 β 3i + residual i – Expected return depends only on sensitivity to sources of systematic return F1, F2, F3, etc. (Security Market Plane) ● E(r i ) = λ + λ 1 β 1i + λ 2 β 2i + λ 3 β 3i What are the factors F? ● Macroeconomic factors ● Statistical factors ● Fundamental factors ● Examples...
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 Fall '10
 Chen, W
 Capital Asset Pricing Model, Probability theory, residuali

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