7.1 CAPM and Empirical Evidence Flashcards
CAPM is based on … which may be violated in reality
Empirical applications of the CAPM are based on the which may be violated in reality.
normality assumption
iid-assumption
Efficient market hypothesis predicts that stock prices are unpredictable -> …
The CAPM rests on the assumption of …
The efficient market hypothesis is tested with …
no exploitable autocorrelation
efficient markets
variance ratio tests
What is the form of the equation used for empirically applying the CAPM?
What’s the assumption behind this model?
(see slide 7)
Returns are assumed to be independent and stationary
Format of the equation of the CAPM to be tested in its ex-post form.
This corresponds to the market model if instead of the market portfolio, a … is used.
Explain the 2 basic assumptions that need to be introduced here.
market index
Stationarity: distribution parameters are stable over time
No autocorrelation: returns are statistically independent
After estimating ß at different points, we can perform a CAPM test.
- Select a data sample (what does it consist of?).
- Define a proxy for the market portfolio and estimate on that basis the market model by carrying out an…
- Test the hypothesis. (what is it?)
- set of stocks, time periods, return periods
- OLS-estimation (according to our assumption, the OLS estimation is efficient and unbiased)
3.
FAMA-MacBeth method
As a first step, you need an estimate of beta.
ß can be time-varying by using … until
t−1.
However, this estimate is usually too noisy.
Alternatively, the betas can be estimated in a portfolio approach.
* Fama and Macbeth (1973) first estimate the …. Then, they assign the firms based on their … into 20 portfolios. Finally, they estimate the betas for each of the portfolios and use it as ….
rolling window time-series regression
pre-ranking betas
a proxy for the beta from each firm within the portfolio
Fama MacBeth regression: steps and results
Step 1: Time-Series Regression to determine factor exposures
Step 2: Cross-Sectional Regression at each point in time t
What are the results?
market beta has a linear relation with returns.
other predictors used in this study cannot predict the cross-section of stocks returns
The results from Fama and Macbeth (1973) do not invalidate the CAPM.
Fama MacBeth regression: further notes
Fama-Macbeth regression can be used to examine the … between a dependent variable and one or more independent variables in the average period.
A statistically significant … indicates a cross-sectional relation between a dependent variable and a independent variable after controlling for the effect of other independent variables.
Nowadays, Fama-Macbeth regression is widely used with …, deciles or percentile ranks.
Benefit: …
cross-sectional relation
average slope coefficient
lagged firm characteristics
control for a large set of potential variables
