Bodie_11e_PPT_Ch13_Investment anaysis.pptx

Bodie's book on Investment

1. Chapter Thirteen Empirical Evidence on Security Returns

2. Expected Return-Beta Relationship Estimating the SCL The Index Model and the Single-Factor SML ©2018 McGraw-Hill Education 13- 2

3. Capital Asset Pricing Models consist of two parts: Optimal P derivation based on risk tolerance and input list Derive predictions about expected returns in equilibrium Overview of Investigation ©2018 McGraw-Hill Education 13- 3

4. Tests of the expected return beta relationship: First Pass Regression Estimate beta, average risk premiums and nonsystematic risk Second Pass Use estimates from the first pass to see if model is supported by the data SML slope is “too flat” and intercept is “too high” Tests of the CAPM ©2018 McGraw-Hill Education 13- 4

5. The only testable hypothesis is whether the market portfolio is mean-variance efficient Sample betas conform to the SML relationship because all samples contain an infinite number of ex post mean-variance efficient portfolios CAPM is not testable unless we know and use the exact composition of the true market portfolio Benchmark error due to proxy for M Roll’s Criticism ©2018 McGraw-Hill Education 13- 5

6. Problem: If beta is measured with error  Slope coefficient of the regression equation will be biased downward Intercept biased upward Solution: Construct P with large dispersion of beta Then, by ranking them, they yield insightful tests of the SML Fama and MacBeth Measurement Error in Beta ©2018 McGraw-Hill Education 13- 6

7. Summary of Fama and MacBeth ©2018 McGraw-Hill Education 13- 7

8. Expected rates of return are linear and increase with beta, the measure of systematic risk Expected rates of return are not affected by nonsystematic risk Summary of CAPM Tests ©2018 McGraw-Hill Education 13- 8

9. Three types of factors likely augment market risk factor: Hedge consumption against uncertainty in prices Hedge future investment opportunities Hedge assets missing from market index Labor income — Mayers model creates wedge between betas, resulting in SML flatter than CAPM’s Tests of the Multifactor CAPM and APT ©2018 McGraw-Hill Education 13- 9

10. Jagannathan and Wang study shows two important deficiencies in tests of the single-index model: Many assets are not traded, notably, human capital A human capital factor may be important in explaining returns Betas are cyclical Human Capital and Cyclical Variations in Asset Betas ©2018 McGraw-Hill Education 13- 10

11. Evaluation of Various CAPM Specifications ©2018 McGraw-Hill Education 13- 11

12. Factors Growth rate in industrial production Changes in expected inflation Unexpected inflation Unexpected changes in risk premiums on bonds Unexpected changes in term premium on bonds Early Versions of the Multifactor Model: Chen, Roll, and Ross ©2018 McGraw-Hill Education 13- 12

13. Method: Two-stage regression with portfolios constructed by size based on market value of equity Significant factors: industrial production, risk premium on bonds, and unanticipated inflation Market index returns were not statistically significant in the multifactor model Study Structure and Results ©2018 McGraw-Hill Education 13- 13

14. High book to market firms experience higher returns (value style) Smaller firms experience higher returns Size and value are priced risk factors, consistent with APT Fama-French-Type Factor Models ©2018 McGraw-Hill Education 13- 14

15. CAPM vs FF Model ©2018 McGraw-Hill Education 13- 15

16. Liew and Vassalou Style seems to predict GDP growth and relate to the business cycle Petkova and Zhang Expansion: value beta < growth beta Recession: value beta > growth beta Risk-Based Interpretations ©2018 McGraw-Hill Education 13- 16

17. Difference in Return to Factor Portfolios ©2018 McGraw-Hill Education 13- 17

18. HML Beta in Different Economic States ©2018 McGraw-Hill Education 13- 18

19. “Glamour firms” Recent good performance High prices Lower book-to-market ratios High prices Excessive optimism Overreaction and extrapolation of good news Studies Chan, Karceski, and Lakonishok LaPorta, Lakonishok, Shleifer, and Vishny Behavioral Explanations for Value Premium ©2018 McGraw-Hill Education 13- 19

20. The Book-to-Market Ratio ©2018 McGraw-Hill Education 13- 20

21. Value minus Glamour Returns Surrounding Earnings Announcements ©2018 McGraw-Hill Education 13- 21

22. The original Fama-French model + Momentum Factor Evaluates abnormal performance of a stock portfolio Winners minus losers (WML) — winners/losers based on past returns Momentum: A Fourth Factor ©2018 McGraw-Hill Education 13- 22

23. Liquidity involves: Trading costs Ease of sale Necessary price concessions to effect a quick transaction Market depth Price predictability Liquidity and Asset Pricing (1 of 3) ©2018 McGraw-Hill Education 13- 23

24. Pástor and Stambaugh studied price reversals May occur when traders have to offer higher purchase prices or accept lower selling prices to complete their trades in a timely manner Conclusion: Liquidity risk is a priced factor Liquidity and Asset Pricing (2 of 3) ©2018 McGraw-Hill Education 13- 24

25. Liquidity and Asset Pricing (3 of 3) ©2018 McGraw-Hill Education 13- 25

26. The equity premium puzzle says: Historical excess returns are too high and/or Our usual estimates of risk aversion are too low Equity Premium Puzzle ©2018 McGraw-Hill Education 13- 26

27. What matters to investors is not their wealth per se, but their lifetime flow of consumption Measure risk as the covariance of returns with aggregate consumption Consumption Growth and Market Rates of Return (1 of 2) ©2018 McGraw-Hill Education 13- 27

28. Annual Excess Returns and Consumption Betas ©2018 McGraw-Hill Education 13- 28

29. The lower panel of Table 13.4 shows: A high book-to-market ratio is associated with a higher consumption beta Larger firm size is associated with a lower consumption beta Consumption Growth and Market Rates of Return (2 of 2) ©2018 McGraw-Hill Education 13- 29

30. Found an equity premium only after 1949 Capital gains significantly exceeded the dividend growth rate in modern times Equity premium may be due to unanticipated capital gains Cross-Section of Stock Returns: Fama-French 25 Portfolios, 1954-2003 ©2018 McGraw-Hill Education 13- 30

31. Risk premiums from the most successful countries without stock markets that did not survive for the full sample period  an upward bias in estimates of expected returns The high realized equity premium obtained for the United States may not be indicative of required returns Survivorship Bias ©2018 McGraw-Hill Education 13- 31

32. Part of the equity premium is almost certainly compensation for liquidity risk rather than just the (systematic) volatility of returns Thus, the equity premium puzzle may be less of a puzzle than it first appears Liquidity and the Equity Premium Puzzle ©2018 McGraw-Hill Education 13- 32

33. Barberis and Huang explain the puzzle as an outcome of irrational investor behavior The premium is the result of narrow framing and loss aversion Investors ignore low correlation of stocks with other forms of wealth Higher risk premiums result Behavioral Explanations of the Equity Premium Puzzle ©2018 McGraw-Hill Education 13- 33