LEC4 - ACCG329 Lecture 4: Informational Efficiency and...

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1 ACCG329 Lecture 4: Informational Efficiency and Model Evaluation 2009, Semester 1 Egon Kalotay Overview of Lecture • Finishing some topics from last week: – Estimation of risk loadings using instrumental variables – Testing and evaluating factor models • We then consider Informational Efficiency: – What does it mean? – What does it imply? • Theoretical • Practical pricing model evaluation
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2 Some Observations from Lecture 3: • Statistical assumptions give rise to a general pricing theory that has a lot of appeal • In principle, factor models provide a simple, flexible way to approach the modeling of covariance risk and return expectations • Applications to asset allocation and various forms of ‘arbitrage’ trading • Need to be careful in applications as there is little if any consensus on model specification and the theory seems to invite data mining • Empirical evidence relating to out of sample usefulness is best described as mixed Single Index Model Estimation Issues • Beta estimates are more reliable at the portfolio level • The average single index model slope coefficient (beta) is 1 • The more extreme a beta the larger the likely estimation error
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LEC4 - ACCG329 Lecture 4: Informational Efficiency and...

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