7 - Chapter 7 The Capital Asset Pricing Model Empirical...

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7-1 Chapter 7 The Capital Asset Pricing Model Empirical examples on class web page “Excel and SAS examples”: - Data on all firm betas - How to calculate CAPM beta for IBM - CAPM performance across B/M deciles
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7-2 Our focus in this chapter CAPM theory versus what we actually observe in the data.
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7-3 Review: What is the CAPM The CAPM is: Where: E(R i ) is the expected return for stock i r f is the risk free rate of interest B i is the beta for security i E(R m ) is the expected return for the market In practice, we use historical data to estimate the risk free rate, a firm’s beta, and the expected market return. [ ] f M i f i r r E r r E - + = ) ( ) ( β
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7-4 It is the equilibrium model that underlies all modern financial theory. Derived using principles of diversification with simplified assumptions. Markowitz, Sharpe, Lintner and Mossin are researchers credited with its development. Capital Asset Pricing Model (CAPM)
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7-5 Single-period investment horizon. Investors are rational mean-variance optimizers ( they use the Markowitz portfolio selection model -only mean and standard deviation matter, that is, the return distribution is normal) All investors have homogeneous expectations (they analyze securities in the same way and share the same economic view of the world). Main Assumptions
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7-6 All investors will hold the same portfolio for risky assets – the VW market portfolio, M (i.e. its proportions among all traded assets).
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