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Chapter_12 - 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 2011 Actsc 372-F11 Chap. 12 Outlines Introduction Announcements, surprises and expected returns Factor models Systematic risks vs unsystematic risks APT vs CAPM Actsc 372-F11 Chap. 12 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-F11 Chap. 12 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-F11 Chap. 12 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 actual return of a stock R : µ note: text uses R U R R U µ = + = + Actsc 372-F11 Chap. 12 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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