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Unformatted text preview: orporate Finance, Tri Vi Dang, Columbia University, Fall 2013 39 I.1.P. Other pricing models, market efficiency Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 40 Remark Empirically, there is very little evidence that CAPM describes the expected returns of stocks. If you take a broad based index (e.g. S&P 500, Russell 5000), you can calculate the Betas of stocks. And using the Betas you can predict expected returns of stocks. The predicted expected returns are not consistent with observed (long run) returns. Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 41 Alternative Pricing Models Arbitrage Pricing Theory (APT) The expected return of asset i is a function of different factors. Ei r f f1 βi1 f 2 βi2 .... f k βi k Factors: GDP, Inflation, Oil price Loadings (Beta) β i cov( xi . f j ) Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 42 Remark APT is a multi factor pricing model CAPM is a single factor model The Market portfolio is the factor. E i r f f1 β i1 rf (u M - rf ) β i 1 Corporate Finance, Tri Vi Dang, Columbia University, Fall 2013 43 Market Efficiency If No Arbitrage holds, there is no profitable trading strategies. If all investors have mean varia...
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