The Capital Assets Pricing Model & Arbitrage Pricing Theory: Properties
Total Page:16
File Type:pdf, Size:1020Kb
Load more
Recommended publications
-
Optimal Life Extension Management of Offshore Wind Farms Based on the Modern Portfolio Theory
Article Optimal Life Extension Management of Offshore Wind Farms Based on the Modern Portfolio Theory Baran Yeter and Yordan Garbatov * Centre for Marine Technology and Ocean Engineering (CENTEC), Instituto Superior Técnico, University of Lisbon, 1049-001 Lisbon, Portugal; [email protected] * Correspondence: [email protected] Abstract: The present study aims to develop a risk-based approach to finding optimal solutions for life extension management for offshore wind farms based on Markowitz’s modern portfolio theory, adapted from finance. The developed risk-based approach assumes that the offshore wind turbines (OWT) can be considered as cash-producing tangible assets providing a positive return from the initial investment (capital) with a given risk attaining the targeted (expected) return. In this regard, the present study performs a techno-economic life extension analysis within the scope of the multi-objective optimisation problem. The first objective is to maximise the return from the overall wind assets and the second objective is to minimise the risk associated with obtaining the return. In formulating the multi-dimensional optimisation problem, the life extension assessment considers the results of a detailed structural integrity analysis, a free-cash-flow analysis, the probability of project failure, and local and global economic constraints. Further, the risk is identified as the variance from the expected mean of return on investment. The risk–return diagram is utilised to classify the OWTs of different classes using an unsupervised machine learning algorithm. The optimal portfolios for the various required rates of return are recommended for different stages of life extension. Citation: Yeter, B.; Garbatov, Y. -
Stock Valuation Models (4.1)
Research STOCK VALUATION January 6, 2003 MODELS (4.1) Topical Study #58 All disclosures can be found on the back page. Dr. Edward Yardeni (212) 778-2646 [email protected] 2 Figure 1. 75 75 70 STOCK VALUATION MODEL (SVM-1)* 70 65 (percent) 65 60 60 55 55 50 50 45 45 RESEARCH 40 40 35 35 30 30 25 25 20 Overvalued 20 15 15 10 10 5 5 0 0 -5 -5 -10 -10 -15 -15 -20 -20 -25 -25 -30 Undervalued -30 -35 12/27 -35 -40 -40 -45 -45 Yardeni Stock ValuationModels -50 -50 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 January 6,2003 * Ratio of S&P 500 index to its fair value (i.e. 52-week forward consensus expected S&P 500 operating earnings per share divided by the 10-year U.S. Treasury bond yield) minus 100. Monthly through March 1994, weekly after. Source: Thomson Financial. R E S E A R C H Stock Valuation Models I. The Art Of Valuation Since the summer of 1997, I have written three major studies on stock valuation and numerous commentaries on the subject.1 This is the fourth edition of this ongoing research. More so in the past than in the present, it was common for authors of investment treatises to publish several editions to update and refine their thoughts. My work on valuation has been acclaimed, misunderstood, and criticized. In this latest edition, I hope to clear up the misunderstandings and address some of the criticisms. -
An Overview of the Empirical Asset Pricing Approach By
AN OVERVIEW OF THE EMPIRICAL ASSET PRICING APPROACH BY Dr. GBAGU EJIROGHENE EMMANUEL TABLE OF CONTENT Introduction 1 Historical Background of Asset Pricing Theory 2-3 Model and Theory of Asset Pricing 4 Capital Asset Pricing Model (CAPM): 4 Capital Asset Pricing Model Formula 4 Example of Capital Asset Pricing Model Application 5 Capital Asset Pricing Model Assumptions 6 Advantages associated with the use of the Capital Asset Pricing Model 7 Hitches of Capital Pricing Model (CAPM) 8 The Arbitrage Pricing Theory (APT): 9 The Arbitrage Pricing Theory (APT) Formula 10 Example of the Arbitrage Pricing Theory Application 10 Assumptions of the Arbitrage Pricing Theory 11 Advantages associated with the use of the Arbitrage Pricing Theory 12 Hitches associated with the use of the Arbitrage Pricing Theory (APT) 13 Actualization 14 Conclusion 15 Reference 16 INTRODUCTION This paper takes a critical examination of what Asset Pricing is all about. It critically takes an overview of its historical background, the model and Theory-Capital Asset Pricing Model and Arbitrary Pricing Theory as well as those who introduced/propounded them. This paper critically examines how securities are priced, how their returns are calculated and the various approaches in calculating their returns. In this Paper, two approaches of asset Pricing namely Capital Asset Pricing Model (CAPM) as well as the Arbitrage Pricing Theory (APT) are examined looking at their assumptions, advantages, hitches as well as their practical computation using their formulae in their examination as well as their computation. This paper goes a step further to look at the importance Asset Pricing to Accountants, Financial Managers and other (the individual investor). -
Arbitrage Pricing Theory∗
ARBITRAGE PRICING THEORY∗ Gur Huberman Zhenyu Wang† August 15, 2005 Abstract Focusing on asset returns governed by a factor structure, the APT is a one-period model, in which preclusion of arbitrage over static portfolios of these assets leads to a linear relation between the expected return and its covariance with the factors. The APT, however, does not preclude arbitrage over dynamic portfolios. Consequently, applying the model to evaluate managed portfolios contradicts the no-arbitrage spirit of the model. An empirical test of the APT entails a procedure to identify features of the underlying factor structure rather than merely a collection of mean-variance efficient factor portfolios that satisfies the linear relation. Keywords: arbitrage; asset pricing model; factor model. ∗S. N. Durlauf and L. E. Blume, The New Palgrave Dictionary of Economics, forthcoming, Palgrave Macmillan, reproduced with permission of Palgrave Macmillan. This article is taken from the authors’ original manuscript and has not been reviewed or edited. The definitive published version of this extract may be found in the complete The New Palgrave Dictionary of Economics in print and online, forthcoming. †Huberman is at Columbia University. Wang is at the Federal Reserve Bank of New York and the McCombs School of Business in the University of Texas at Austin. The views stated here are those of the authors and do not necessarily reflect the views of the Federal Reserve Bank of New York or the Federal Reserve System. Introduction The Arbitrage Pricing Theory (APT) was developed primarily by Ross (1976a, 1976b). It is a one-period model in which every investor believes that the stochastic properties of returns of capital assets are consistent with a factor structure. -
A Financially Justifiable and Practically Implementable Approach to Coherent Stress Testing
———————— An EDHEC-Risk Institute Working Paper A Financially Justifiable and Practically Implementable Approach to Coherent Stress Testing September 2018 ———————— 1. Introduction and Motivation 5 2. Bayesian Nets for Stress Testing 10 3. What Constitutes a Stress Scenario 13 4. The Goal 15 5. Definition of the Variables 17 6. Notation 19 7. The Consistency and Continuity Requirements 21 8. Assumptions 23 9. Obtaining the Distribution of Representative Market Indices. 25 10. Limitations and Weaknesses of the Approach 29 11. From Representative to Granular Market Indices 31 12. Some Practical Examples 35 13. Simple Extensions and Generalisations 41 Portfolio weights 14. Conclusions 43 back to their original References weights, can be a 45 source of additional About EDHEC-Risk Institute performance. 48 EDHEC-Risk Institute Publications and Position Papers (2017-2019) 53 ›2 Printed in France, July 2019. Copyright› 2EDHEC 2019. The opinions expressed in this study are those of the authors and do not necessarily reflect those of EDHEC Business School. Abstract ———————— We present an approach to stress testing that is both practically implementable and solidly rooted in well-established financial theory. We present our results in a Bayesian-net context, but the approach can be extended to different settings. We show i) how the consistency and continuity conditions are satisfied; ii) how the result of a scenario can be consistently cascaded from a small number of macrofinancial variables to the constituents of a granular portfolio; and iii) how an approximate but robust estimate of the likelihood of a given scenario can be estimated. This is particularly important for regulatory and capital-adequacy applications. -
Arbitrage Pricing Theory
Federal Reserve Bank of New York Staff Reports Arbitrage Pricing Theory Gur Huberman Zhenyu Wang Staff Report no. 216 August 2005 This paper presents preliminary findings and is being distributed to economists and other interested readers solely to stimulate discussion and elicit comments. The views expressed in the paper are those of the authors and are not necessarily reflective of views at the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors. Arbitrage Pricing Theory Gur Huberman and Zhenyu Wang Federal Reserve Bank of New York Staff Reports, no. 216 August 2005 JEL classification: G12 Abstract Focusing on capital asset returns governed by a factor structure, the Arbitrage Pricing Theory (APT) is a one-period model, in which preclusion of arbitrage over static portfolios of these assets leads to a linear relation between the expected return and its covariance with the factors. The APT, however, does not preclude arbitrage over dynamic portfolios. Consequently, applying the model to evaluate managed portfolios is contradictory to the no-arbitrage spirit of the model. An empirical test of the APT entails a procedure to identify features of the underlying factor structure rather than merely a collection of mean-variance efficient factor portfolios that satisfies the linear relation. Key words: arbitrage, asset pricing model, factor model Huberman: Columbia University Graduate School of Business (e-mail: [email protected]). Wang: Federal Reserve Bank of New York and University of Texas at Austin McCombs School of Business (e-mail: [email protected]). This review of the arbitrage pricing theory was written for the forthcoming second edition of The New Palgrave Dictionary of Economics, edited by Lawrence Blume and Steven Durlauf (London: Palgrave Macmillan). -
The Predictive Ability of the Bond-Stock Earnings Yield Differential Model
The Predictive Ability of the Bond-Stock Earnings Yield Differential Model KLAUS BERGE,GIORGIO CONSIGLI, AND WILLIAM T. ZIEMBA FORMAT ANY IN KLAUS BERGE he Federal Reserve (Fed) model prices and stock indices has been studied by is a financial controller provides a framework for discussing Campbell [1987, 1990, 1993]; Campbell and for Allianz SE in Munich, stock market over- and undervalu- Shiller [1988]; Campbell and Yogo [2006]; Germany. [email protected] ation. It was introduced by market Fama and French [1988a, 1989]; Goetzmann Tpractitioners after Alan Greenspan’s speech on and Ibbotson [2006]; Jacobs and Levy [1988]; GIORGIO CONSIGLI the market’s irrational exuberance in ARTICLELakonishok, Schleifer, and Vishny [1994]; Polk, is an associate professor in November 1996 as an attempt to understand Thompson, and Vuolteenaho [2006], and the Department of Mathe- and predict variations in the equity risk pre- Ziemba and Schwartz [1991, 2000]. matics, Statistics, and Com- mium (ERP). The model relates the yield on The Fed model has been successful in puter Science at the THIS University of Bergamo stocks (measured by the ratio of earnings to predicting market turns, but in spite of its in Bergamo, Italy. stock prices) to the yield on nominal Treasury empirical success and simplicity, the model has [email protected] bonds. The theory behind the Fed model is been criticized. First, it does not consider the that an optimal asset allocation between stocks role played by time-varying risk premiums in WILLIAM T. Z IEMBA and bonds is related to their relative yields and the portfolio selection process, yet it does con- is Alumni Professor of Financial Modeling and when the bond yield is too high, a market sider a risk-free government interest rate as the Stochastic Optimization, adjustment is needed resulting in a shift out of discount factor of future earnings. -
Dividend Valuation Models Prepared by Pamela Peterson Drake, Ph.D., CFA
Dividend valuation models Prepared by Pamela Peterson Drake, Ph.D., CFA Contents 1. Overview ..................................................................................................................................... 1 2. The basic model .......................................................................................................................... 1 3. Non-constant growth in dividends ................................................................................................. 5 A. Two-stage dividend growth ...................................................................................................... 5 B. Three-stage dividend growth .................................................................................................... 5 C. The H-model ........................................................................................................................... 7 4. The uses of the dividend valuation models .................................................................................... 8 5. Stock valuation and market efficiency ......................................................................................... 10 6. Summary .................................................................................................................................. 10 7. Index ........................................................................................................................................ 11 8. Further readings ....................................................................................................................... -
A Theory of Speculative Bubbles, the Fed Model, and Self-Fulfilling
Monetary Exchange in Over-the-Counter Markets: A Theory of Speculative Bubbles, the Fed Model, and Self-fulfilling Liquidity Crises Ricardo Lagos∗ Shengxing Zhangy New York University London School of Economics September 2014 Abstract We develop a model of monetary exchange in over-the-counter markets to study the ef- fects of monetary policy on asset prices and standard measures of financial liquidity, such as bid-ask spreads, trade volume, and the incentives of dealers to supply immediacy, both by participating in the market-making activity and by holding asset inventories on their own account. The theory predicts that asset prices carry a speculative premium that reflects the asset's marketability and depends on monetary policy as well as the microstructure of the market where it is traded. These liquidity considerations imply a positive correlation between the real yield on stocks and the nominal yield on Treasury bonds|an empirical observation long regarded anomalous. The theory also exhibits rational expectations equi- libria with recurring belief driven events that resemble liquidity crises, i.e., times of sharp persistent declines in asset prices, trade volume, and dealer participation in market-making activity, accompanied by large increases in spreads and abnormally long trading delays. Keywords: Money; Liquidity; OTC markets; Asset prices; Fed model; Financial crises JEL classification: D83, E31, E52, G12 ∗Lagos thanks the support from the C.V. Starr Center for Applied Economics at NYU. yZhang thanks the support from the Centre -
11Portfolio Concepts
CHAPTER 11 PORTFOLIO CONCEPTS LEARNING OUTCOMES After completing this chapter, you will be able to do the following: Mean–Variance Analysis I Define mean–variance analysis and list its assumptions. I Explain the concept of an efficient portfolio. I Calculate the expected return and variance or standard deviation of return for a portfolio of two or three assets, given the assets’ expected returns, variances (or standard deviations), and correlation(s) or covariance(s). I Define the minimum-variance frontier, the global minimum-variance portfolio, and the efficient frontier. I Explain the usefulness of the efficient frontier for portfolio management. I Describe how the correlation between two assets affects the diversification benefits achieved when creating a portfolio of the two assets. I Describe how to solve for the minimum-variance frontier for a set of assets, given expected returns, covariances, and variances with and without a constraint against short sales. I Calculate the variance of an equally weighted portfolio of n stocks, given the average variance of returns and the average covariance between returns. I Describe the capital allocation line (CAL), explain its slope coefficient, and calculate the value of one of the variables in the capital allocation line given the values of the remaining variables. I Describe the capital market line (CML), explain the relationship between the CAL and the CML, and interpret implications of the CML for portfolio choice. I Describe the capital asset pricing model (CAPM) including its underlying assumptions, resulting conclusions, security market line, beta, and market risk premium. I Explain the choice between two portfolios given their mean returns and standard deviations, with and without borrowing and lending at the risk-free rate. -
Module 8 Investing in Stocks
Module 8 Investing in stocks Prepared by Pamela Peterson Drake, Ph.D., CFA 1. Overview When an investor buys a WARREN BUFFETT ON INTRINSIC VALUE share of common stock, it is reasonable to expect From the 1994 annual report to shareholders of Berkshire Hathaway1 that what an investor is willing to pay for the “We define intrinsic value as the discounted value of the cash that can share reflects what he be taken out of a business during its remaining life. Anyone calculating intrinsic value necessarily comes up with a highly subjective figure that expects to receive from it. will change both as estimates of future cash flows are revised and as What he expects to interest rates move. Despite its fuzziness, however, intrinsic value is receive are future cash all-important and is the only logical way to evaluate the relative flows in the form of attractiveness of investments and businesses. dividends and the value … of the stock when it is To see how historical input (book value) and future output (intrinsic value) can diverge, let's look at another form of investment, a college sold. education. Think of the education's cost as its "book value." If it is to be accurate, the cost should include the earnings that were foregone by The value of a share of the student because he chose college rather than a job. stock should be equal to the present value of all For this exercise, we will ignore the important non-economic benefits the future cash flows you of an education and focus strictly on its economic value. -
Capital Asset Pricing Model and Arbitrage Pricing Theory in the Italian Stock Market: an Empirical Study
Capital Asset Pricing Model and Arbitrage Pricing Theory in the Italian Stock Market: an Empirical Study ∗ ARDUINO CAGNETTI ABSTRACT The Italian stock market (ISM) has interesting characteristics. Over 40% of the shares, in a sample of 30 shares, together with the Mibtel market index, are normally distributed. This suggests that the returns distribution of the ISM as a whole may be normal, in contrast to the findings of Mandelbrot (1963) and Fama (1965). Empirical tests in this study suggest that the relationships between β and return in the ISM over the period January 1990 – June 2001 is weak, and the Capital Asset Pricing Model (CAPM) has poor overall explanatory power. The Arbitrage Pricing Theory (APT), which allows multiple sources of systematic risks to be taken into account, performs better than the CAPM, in all the tests considered. Shares and portfolios in the ISM seem to be significantly influenced by a number of systematic forces and their behaviour can be explained only through the combined explanatory power of several factors or macroeconomic variables. Factor analysis replaces the arbitrary and controversial search for factors of the APT by “trial and error” with a real systematic and scientific approach. The behaviour of share prices, and the relationship between risk and return in financial markets, have long been of interest to researchers. In 1905, a young scientist named Albert Einstein, seeking to demonstrate the existence of atoms, developed an elegant theory based on Brownian motion. Einstein explained Brownian motion the same year he proposed the theory of relativity. At that time his results were considered completely revolutionary.