Asset Pricing Models (7) Flashcards
(13 cards)
What does the risk premium of a security depend on?
Its systematic risk
What is the Capital Asset Pricing Model (CAPM)?
A model for estimating required return on equity for a given level of systematic risk
What does β represent in the equation of the Security Market Line (SML)?
The sensitivity of a company or portfolio’s returns to market movements.
What does:
β<1
β>1
β=1
β-0
suggest?
β<1 less sensitive then market
β>1 more sensitive than market
β = 1 market portfolio
β = 0 risk free asset returns
What two points will the security market line go through?
Risk-free investment
Market portfolio
According to CAPM what is the relationship between expected return and beta for individual securities
They should all plot onto the security market line (SML).
Can any shares or portfolios lie above or below the SML?
Nothing would plot consistently above or below the SML
What is a criticism of CAPM as a satisfactory model for risk and return?
Its impossible to test the market portfolio as market indices only contain samples of stocks
What is the Arbitrage Pricing Theory Model (APT)?
A different model for return that assumes stock returns depend partly on: economic influences/factors and “noise” - events unique to the company
What does b represent in the ATP model?
the sensitivity to each factor
What are some similarities of CAPM and APT?
Expected return depends on risk stemming from economy wide influences
What are some differences between CAPM and APT?
There is only one determinant factor for return in CAPM (return on market)
What is the Fama-French Three-Factor model?
A model in the format of APT but with the specific factors:
1) Return on market index minus risk-free return
2) Return on a portfolio of small stocks minus return on portfolio of large stocks
3) Return o portfolio of value stocks minus return on portfolio of growth stocks
