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Lesson 3-2: Testing the CAPM and Market Anomalies

Learning Objectives:

• Why discount
• Different return measures
• Firm Characteristics Relevant for Investments
• Zero-Cost Portfolio (long-short strategies)
• Statistical Techniques and Excel

Recall

Uses of CAPM

Corporate Finance

Asset Management Industry

CAPM Problems as an Asset Pricing Model (Market Anomalies)

Small-firm

Value Effects (Book-to-Market)

Market Anomalies Factors

Notes

• benchmark return that a project needs to yield to be acceptable to investors

• Useful for a firm's capital budgeting decisions

  • Should a firm retain earnings or pay them out as dividends?

• assess whether an investment has outperformed or underperformed in the past, given its risk

• Useful to compare the performance of different investments (or fund managers) with different underlying risk

• CAPM is a starting point, but more complicated models will be used to assess performance

  • Think about spreadsheets by finance bros.

Example of anomaly is Momentum

• stocks of small firms have earned abnormal returns (particularly in January

• Stocks with high book-to-market ratios (value stocks) tend to outperform stocks with low book-to-market ratios (growth stocks)

• Risk

• Irrational Behavior

• Data Mining

  • correlation does not mean causation

Lesson 3-3: Multi-Factor Models and Matching

Recall

ARBITRAGE PRICING THEORY (APT)

APT and Multi-factor Models

Fama-French 3-Factor Model

1. Market Factor

2. Size Factor (SMB)

• SMB Coefficient $(B_{iSMB})$

1. Value or Book-to-Market Factor (HML)

Matching

<aside> 📌 SUMMARY: Multi-factor models account for types of risk that manifested in various types of returns.

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Lesson 3-6: Market Efficiency