CAPM (Capital Asset Pricing Model)

1. We've covered a few of the major models for explaining security market returns this week in your readings and lectures, what do you think?

Are returns best explained by Market Risk (aka, Beta)?

Are multiple factors needed to explain returns?

Could you offer a concise explanation to a client of "how the world works?"(A worldview, or set of beliefs about how the economy and markets work, you can build a coherent and consistent investment philosophy to guide your work with clients.)

What would that be?

2. A number of investment strategies based on risk factor research have been lumped under the heading "smart beta," but are they smart?

What are the arguments for and against smart beta strategies and what are the alternative explanations for why they should or shouldn't work?

References:

Capital Asset Pricing Model (CAPM) GULDE Portfolio Risk Total Risk Firm Specific Risk Market Risk 10 20 Number of Securities BUSINESS | TAXATION | ACCOUNTING | LAW GOLDEN GATE UNIVERSITY 2Capital Asset Pricing Model (CAPM) Central Proposition: Returns are related to Systematic Risk only GOLDEN GATE UNIVERSITY Systematic Risk vs Systematic Errors Systematic Factor Systematic-Risk Theory Systematic-Error Theory Value Higher systematic Errors-in-expectations (business cycle) risk Loss aversion Investment-flows-based theory Low Size (small Higher systematic . Errors-in-expectations cap) (business cycle) risk . Proxy for other types of systematic risk Momentum . Higher systematic Underreaction and (business cycle) risk overreaction . Higher systematic risk Investment-flows-based theory Dividend Yield . Higher systematic Lotter effect (business cycle) risk Overconfidence effect Leverage aversion Quality NA . Errors-in-expectations BUSINESS | TAXATION | ACCOUNTING | LAW GOLDEN GATE UNIVERSITY 15Investment Philosophy I Must begin with a theory/understanding for how the economy works I Must have a theory/understanding of how markets work, where returns come from I Worldview gives rise to investment philosopy I Operationalize I Being grounded and policy-based supports consistency of approach and execution GOLDEN GATE UNIVERSITY