This preview has intentionally blurred sections. Sign up to view the full version.View Full Document
Unformatted text preview: LECTURE 13, PORTFOLIO THEORY, CONTINUED, BA 133, SINGLE AND MULTI-FACTOR MODELS. What are our goals in Chapter X? After today I hope you will understand: 1. an introduction to the excess returns version of the CAPM (which you should have seen by now, either in here or in BA 103), 2. how betas are calculated using historical data, 3. beta books and the industry’s version of the CAPM 4. predicting betas 5. empirical results of the CAPM, or “what can go wrong?” 6. multifactor models: Rosenberg and Guy Chen, Ross and Roll Fama and French Let’s take the above, topic by topic… In 2002 the Berkeley finance faculty honored Harry Markowitz, at a two day seminar at Silverado. As the keynote speaker, he reminisced about his work developing portfo- lio theory. 2002 was the 50 th anniversary of his now famous Journal of Finance article. In his talk he discussed the problem of calculating portfolio variances, and in effect claimed he gave to William Sharpe, the idea of focusing on the risk of a well diversi- fied portfolio, when he was teaching at UCLA, where Sharpe was a doctoral student. He also acknowledged the work of a competitor in developing portfolio theory, noting that the other author failed to publish anything else did not share the Nobel prize in “financial economics.” In a humorous tone, Dr. Markowitz announced he was more deserving than the other guy. As you now know, Sharpe invented the concept of beta and the capital asset pricing model, published his Journal of Finance article, in 1964. For his effort, he shared with Harry Markowitz, the Nobel prize in economics given in 1992. The importance of Sharpe’s paper was the ability to avoid calculating thousands of co- variances in an era of limited computer access. (For a perspective, ten years later, in 1972 I decided not to pay $150 for a four function calculator). The Nobel committee cited Sharpe’s contribution as one of greatly simplifying portfolio risk management. * * * * * * * * * * * * 1 The CAPM is an example of a single factor model, although the CAPM came first. Since the CAPM, other single variable equations have been tested without success. In theory the CAPM is supposed to be the superior model, and beta is a complete risk descriptor, i.e., there is no need for any other single or multifactor model. You know by the title of Chapter 10, that beta doesn’t deliver what it promises to accomplish. Out of necessity, Barr Rosenberg began building models with more than beta as an in- dependent variable, and became wealthy and famous, the two goals of all finance pro- fessors. (More about him and his work when we get to predicting betas). Remember: the market risk premium is the slope of the CAPM, a single variable equa- tion, and that beta locates, on the X axis, just “exactly” where we wish to position ourselves in a return-to-risk framework....
View Full Document
This note was uploaded on 12/06/2011 for the course UGBA 133 taught by Professor Distad during the Summer '08 term at Berkeley.
- Summer '08