ec567 wk3 17sep 2013(1) - II CIANTWOMEY WEEK#3:17...

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EC567 FINANCIAL ECONOMETRICS  II: APPLIED PORTFOLIO MODELLING CIAN TWOMEY WEEK #3:  17  September 2013
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Recap  Single Index Model  (SIM)  n  What does SIM assume about the sources  of risk for an individual share? n What does the single index model (SIM)  imply for  (i) the determinants of the volatility of  individual stock returns?  (ii) the correlation (or covariance) between  any two stock returns?
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Overview of Week 3 i. Performance evaluation ii. Market timing iii. Performance attribution iv. Active vs. passive portfolio  management
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Performance Evaluation  n Investment returns and abnormal  performance n One-parameter measures n Market Timing n Performance Attribution n Evidence on Fund Performance 
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Performance Evaluation  n Portfolio evaluation has three steps: n Performance measurement - input n how well the portfolio performed n Performance attribution – output n identify the risk factors that best explain performance n by inference, the impact on performance of the manager’s  investment decisions n Performance appraisal – interpretation n returns due to greater market risk or portfolio manager skill
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Introduction n How do we measure the performance of a fund manager? n against some agreed benchmark? n by comparing with other Fund Managers? n How do we compute the average return achieved by a  Fund Manager over a period of time? n complicated by interim inflows and outflows of cash  outside the Fund Manager’s control (hence stock return  is not just the sum of capital gains and dividends  divided by the initial investment) n What do we mean by “risk”? n How do we adjust portfolio return for risk? (total risk or  non-diversifiable risk?)
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 Measuring Investment Returns n Ex-post  returns are  realised  returns n historical data n Ex-ante  returns are  expected  returns n theoretical predictions n different models give different predictions n Performance measurement compares ex-post  returns on a portfolio with … n ex-post  returns on other portfolios n ex-ante  returns predicted by some model (e.g. CAPM  using  ex-post  returns on the market) [NB:  risk-adjusted returns]
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Abnormal performance is measured: n Benchmark portfolio n Market adjusted n Market model / index model adjusted n Reward to risk measures such as the Sharpe Measure: E (rp-rf) /  σ p n Factors Leading to Abnormal Performance  a) Market timing b) Superior selection n Sectors or industries n Individual companies Abnormal Performance
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Abnormal returns n Difference between the ex-post returns that is  actually observed and the ex-ante return that is  expected on the basis of some model: AR(t) ”  r(t) - E[r(t)] Here, E[r(t)]  denotes the return which the model would 
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