chapter12 - Chapter 12: An Alternative View of Risk and...

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Chapter 12 : An Alternative View of Risk and Return: The Arbitrage Pricing Theory Ken Seng Tan Actsc 372 Fall 2008 Actsc 372-F08 Chap. 12 2 Outlines ± Introduction ± Announcements, surprises and expected returns ± Factor models ± Systematic risks vs unsystematic risks ± APT vs CAPM Actsc 372-F08 Chap. 12 3 Arbitrage Pricing Theory (APT) ± Recall that CAPM posits a positive (and linear) relationship between the beta of a security and its expected return ± β measures the responsiveness of a security’s return to the return on the market portfolio . ± Market portfolio is the only relevant risk factor ± One-factor model ± APT - another competing theory ± Proposed by Ross (1976) ± Assume that each stock return depends partly on macroeconomic influences or “factors” and party on “noise” (events that are unique to that company) ± Factor models
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Actsc 372-F08 Chap. 12 4 12.1 Factor Models: Announcements, Surprises, and Expected Returns ± The return on any security consists of two parts. 1. the expected or normal return: ± the return that shareholders in the market predict or expect 2. the unexpected or risky return: ± the portion that comes from information that will be revealed ± Examples of relevant information: ± Statistics Canada figures (e.g., GNP) ± A sudden drop in interest rates ± News that the company’s sales figures are higher than expected Actsc 372-F08 Chap. 12 5 The Impact of Announcements/News ± When a company makes an announcement, what is the impact on its stock price? ± Announcement = Expected part + Surprise/Innovation . ± The expected part of any announcement is part of the information the market uses to form the expectation, of the return on the stock. ± The surprise is the news that influences the unanticipated return on the stock, U . ± Therefore, the total return of a stock R : μ note: text uses R UR R U = += + Actsc 372-F08 Chap. 12 6 Systematic Risk vs Unsystematic Risk ± A systematic risk is any risk that affects a large number of assets, each to a greater or lesser degree.
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chapter12 - Chapter 12: An Alternative View of Risk and...

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