A.04.BKM Ch 09

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A.04.BKM Ch 09
2012-05-07 13:50:40

Capital Asset Pricing Model
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  1. CAPM Assumptions
    • many investors, all price-takers (small wealth)
    • investors plan for one holding period
    • investors are limited to publicly traded fin assets
    • investors can borrow or lend at rf
    • no tx or transaction cost
    • all investors are rational mean-var optimizers (hold mkt)
    • investors have homogeneous expectations
  2. CAPM Assumptions Implications
    • all investors will hold mkt pf M
    • CML is best attainable CAL
  3. Derivation of CAPM
    • contribution of indiv stock to RP = wi[E(ri)-rf]
    • contribution to var = wiCov(ri,rM)
    • Sharpe = [E(ri)-rf] / Cov(ri,rM)
    • Set equal to mkt sharpe (equilibrium)
  4. Security Market Line
    • graphs the relationship btwn beta and E(r)
    • underpriced assets have positive alpha and lie above SML
    • CML = pf E(r) vs sd, SML = individual assets E(r) vs beta
  5. CAPM: actual vs expected return
    • hard to test CAPM because it produces exp return but can only be tested using actual return
    • model might work even if actual is diff from expected
  6. CAPM vs Single Index Model
    • SIM uses actual return
    • CAPM implicitly assumes alpha is zero for all securities
    • SIM states the average alpha is zero, but not necessarily for indiv securities
  7. Extensions of CAPM
    • Zero-beta: zero-beta pf equivalent to efficient on inefficient side, w zero correlation
    • Non-traded asset: human capital, privately held business (similar to traded = little impact, others = negative alpha to hedge)
    • Labor Income:
    • Multiperiod: chg in inv opportunities parameters, chg in price of consumption goods (prices bid up)
    • Liquidity adj: bid/ask spread for trading (clientele effect); liquidity risk (liquidity beta)