Transcript Economics 434 Financial Markets - SHANTI Pages

Economics 434
Financial Markets
Professor Burton
University of Virginia
Fall 2015
September 24, 2015
Definition of an Asset in Modern
Portfolio Theory:
As a probability distribution of returns (usually a normal distribution)
Probability Density Function
-- Returns -Instead of three (or any finite number of) states, there are
an infinity of states possible with various probabilities
of returns assigned
September 18, 2014
Modern Portfolio Theory
• Randomness
• Construction of efficient
(best) portfolios
Harry Markowitz
September 18, 2014
Harry Markowitz’s Conclusion
Mean
Maximizes
Utility
Standard Deviation
September 18, 2014
James Tobin’s Result
Mean
Use of Leverage
E
Risk Free
Asset
Standard Deviation
September 18, 2014
CAPM – two conclusions
Bill Sharpe
• M – the “efficient” basket
• The pricing rule based upon “beta”
September 18, 2014
Capital Market Line
Mean
M
Rf
What is M ?
Answer: contains all “positively”
priced assets, weighted by their
“market” values.
STDD
September 18, 2014
Security Market Line
i = Rf + i [M – Rf]
Mean
i
M
Rf
Security Market Line
Beta
1
September 18, 2014
Is CAPM Testable?
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Richard Roll – UCLA, 1982
Not a testable theory
Can’t find market basket
Without true market basket, can reach
wrong conclusion
• Is Beta dead?
September 18, 2014
Fama-French
• 1982 by Eugene Fama and Kenneth French
• Research designed to test whether or not CAPM is
true
– Findings
• Beta is largely irrelevant
• Book/Market positively related to future
performance
• Size negatively related to future
performance
September 18, 2014
Performance Evaluation
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Absolute Return Doesn’t Tell You Much
Need to Know What Risk Was Taken
Beta is the normal measure of risk
“Risk Adjusted” Performance is now the
norm
September 18, 2014
Roll’s Criticism Applies Here
• Data might show superior
performance
• When performance is
actually inferior
• Data might show inferior
performance
• When performance is
actually superior
September 18, 2014
Two Things Keep Beta Going
• The Limit Theorem
• Ease of Computation
September 18, 2014
September 24, 2015