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CHAPTER 7
Risk and Return: Portfolio Theory and
Asset Pricing Models
Capital Asset Pricing Model (CAPM)
Efficient frontier
Capital Market Line (CML)
Security Market Line (SML)
Beta calculation
Arbitrage pricing theory
Fama-French 3-factor model
Copyright © 2002 Harcourt, Inc. All rights reserved.
7-2
Feasible Set
Risk, p
Feasible and Efficient Portfolios
Copyright © 2002 Harcourt, Inc. All rights reserved.
7-6
Optimal Portfolio
IA2 Investor B
IA1
Optimal Portfolio
Investor A
Risk p
Optimal Portfolios
Copyright © 2002 Harcourt, Inc. All rights reserved.
7-8
Expected Z
Return, kp
. B
^
kM
M
.
The Capital Market
kRF
A . Line (CML):
New Efficient Set
M Risk, p
Copyright © 2002 Harcourt, Inc. All rights reserved.
7 - 11
^
^ kM - kRF
kp = kRF + p.
M
Intercept Slope
Risk
measure
Copyright © 2002 Harcourt, Inc. All rights reserved.
7 - 13
^
kM
^k
.
R
. M
R
R = Optimal
kRF Portfolio
R M Risk, p
Copyright © 2002 Harcourt, Inc. All rights reserved.
7 - 15
ki = kRF + (RPM) bi
-5 0 5 10 15 20
_
kM
-5
^
ki = -2.59 + 1.44 ^
kM
. -10
Copyright © 2002 Harcourt, Inc. All rights reserved.
7 - 19
Method of Calculation
(More...)
Copyright © 2002 Harcourt, Inc. All rights reserved.
7 - 20
Yes.
Richard Roll questioned whether it was
even conceptually possible to test the
CAPM.
Roll showed that it is virtually
impossible to prove investors behave
in accordance with CAPM theory.
CAPM:
ki = kRF + (kM - kRF)bi
ki = 6.8% + (6.3%)(0.9)
= 12.47%