{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

Slide 10 MVE CAPM FM CCAPM

Slide 10 MVE CAPM FM CCAPM - Mean Variance Efficiency CAPM...

Info icon This preview shows pages 1–10. Sign up to view the full content.

View Full Document Right Arrow Icon
Mean Variance Efficiency, CAPM, the SML, Factor Model and CCAPM By Diep Duong
Image of page 1

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Outline Returns Expected Returns and Variances Portfolios, Mean-Variance Efficiency Announcements, Surprises, and Expected Returns Risk: Systematic and Unsystematic Diversification and Portfolio Risk Systematic Risk and Beta The Security Market Line CAPM The SML and the Cost of Capital: A Preview Factor Model and Regression A quick tour on Consumption based Asset Pricing Model
Image of page 2
Some Motivations In previous topics, we mostly talk about Present Value Model Basically, PV is an Pricing Problem, how to price assets in the market We mention about risk and return but in a informal way. Can we set things up formally ? Secondly, in economics, rationality is important. People optimize their own benefits. If you invest, then what is your decision rule (Strategy) if you are economically rational ?
Image of page 3

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Financial Asset Return Financial Assets could be stock, bonds, futures,… Financial assets generate income and are traded in the markets The same rule - return is composed of two parts - Return due to Income (gain) - Return due to Capital Gain Another simple but important rule, at today time, - We know everything in the past (Certain) - We do not know anything about future (Uncertain) When things are uncertain or random, we work with Random Variable
Image of page 4
Asset Returns as Random Variables So we want to think of asset return to be a Random Variable. It’s random because of the uncertain states of our world Things become more complicated - What do we mean when you say you know Return of stock A in this case ? - If we describe a RV, we only can tell about all possibilities, or a distribution of it. Actually, in finance, practitioners often care about EXPECTATION and VARIANCE (The first two moments) of Asset Return
Image of page 5

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Expected Returns Expected returns are based on the probabilities of possible outcomes In this context, “expected” means “average” if the process is repeated many times “Average” here does not necessarily mean equal weights. The weights sum up to 1. For Discrete RV or Continuous RV R of density is where ) ( ) ( : Outcome Continuous ) ( : Outcome Discrete 1 f dr r rf R E R p R E n i i i = = = = μ
Image of page 6
Example: Expected Returns Suppose you have predicted the following returns for stocks C and T in three possible states of the economy. What are the expected returns? State Probability C T Boom 0.3 15 25 Normal 0.5 10 20 Recession ??? 2 1 R C = .3(15) + .5(10) + .2(2) = 9.9% R T = .3(25) + .5(20) + .2(1) = 17.7%
Image of page 7

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Variance and Standard Deviation Variance and standard deviation (square root of variance) measure the volatility of returns Using unequal probabilities for the entire range of possibilities Weighted average of squared deviations - = - = = dr r f R E r R E R p n i i i ) ( )) ( ( σ Outcome Continuous )) ( ( σ Outcome Discrete 2 2 1 2 2
Image of page 8
Example Consider the previous example. What are the variance and standard deviation for each stock?
Image of page 9

Info icon This preview has intentionally blurred sections. Sign up to view the full version.

View Full Document Right Arrow Icon
Image of page 10
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern