Capital Asset Pricing Theory Research Articles

Local government structure and the quality of minority neighborhoods

One of the most long-standing and controversial issues surrounding local government structure in the United States is how “reformed” political institutions have impacted minority neighborhoods. A common belief is that reformism has harmed these neighborhoods, but there is no empirical evidence on this issue. Drawing upon capital asset pricing theory, this paper empirically investigates the effects of two reforms, the council-manager form of government and at-large councilor elections, on the quality of nonwhite neighborhoods. Quality is found to be higher in majority white places with at-large as opposed to district-based elections. Quality is not found to be affected by the form of government.

L’impact des signaux de politique monétaire sur la rentabilité, la volatilité et la prime de risque : le cas du marché boursier français

The aim of this paper is to investigate the response of the French stock market to US and European central banks’ monetary policy announcements, by distinguishing between different financial cycles. To this end, we rely on both the event-study methodology and the International Capital Asset Pricing theory, and decompose the monetary policy announcements into anticipated and unanticipated components. We show that the response of the French stock market is asymmetric. The impact of ECB decisions - which generally aim at limiting the inflation risk - is stronger during high financial states, whereas, the effect of US announcements-centred on the management of the global risk-is stronger in slump periods.

A method of project selection based on capital asset pricing theories in a framework of mean–semideviation behavior

The competitiveness of a firm especially in the capital-intensive industries is highly dependent to a stream of successful and profitable projects. Having simulated the financial outcomes of a project, analysis of the output of simulation is then an important task that demands efficient methods for evaluation and selection of projects. The method in this article considers semideviation of return as the measure of risk of projects that is more consistent with the definition of risk as “the probability of unwanted outcomes”. Projects characterized by their expected return and semideviation of return are then entered into a project comparison system that is based on the arbitrage pricing theory (APT). The primary advantage of this method of project selection is in the collective assessment of the firm’s risk by all market participants.

Derman and Taleb's 'The Illusions of Dynamic Replication': A Comment

While as a matter of pure chance and mathematical manipulations, the Black-Scholes formula could have been accidentally obtained much earlier by making use of put-call parity, a simple thought experiment demonstrates the inconclusiveness of any such derivation as regards the validity of the resulting pricing equation. In particular, the use of a non-stochastic discount rate common to both the call and the put options is inconsistent with modern equilibrium capital asset pricing theory. Additional observations are made.

NONNESTED PROCEDURES IN ECONOMETRIC TESTS OF ASSET PRICING THEORIES

AbstractIn this paper nonnested tests are used to contrast the performance of the capital asset pricing (CAPM) and consumption capital asset pricing (CCAPM) theories in describing the U.S. stock market. The procedures employed include the N‐test, the NT‐test, the W‐test, the J‐test, and the Encompassing test. The tests are carried out using data on firms as well as portfolios based on beta, capitalization, and Standard Industrial Classification codes. The findings indicate that although during 1973–82 the CAPM dominates the CCAPM, during 1978–87 the results are mixed, and during 1983–92 the CCAPM dominates. The finding in favor of the CCAPM in 1983–92 conflicts with much of the existing literature, which favors the CAPM.

LINEAR CONDITIONAL EXPECTATION, RETURN DISTRIBUTIONS, AND CAPITAL ASSET PRICING THEORIES

AbstractWe show that E[X(g(Y1, …, Yn)] (where E[.] is the expectation operator) can be decomposed into a product of two expected values plus a sum of n comovement terms, if X, Y1, …, Yn follow a distribution that admits linear conditional expectation (LCE). We then apply this relation to show that if each asset return is LCE distributed with the market and/or the factors, many capital asset pricing models and the mutual fund separation theorem can be obtained. A well‐known example of a class of distributions that admits LCE is the elliptical distributions, of which the normal is a special case. A larger family, not mentioned in the existing literature, that admits LCE is the Pearson system. As a result, the distribution assumption to derive the capital asset pricing theories can be relaxed to the wider LCE family. We also present the relation of the LCE family to Ross's (1978) separating distribution family.

Investment Basics: XXXIV. The arbitrage pricing theory

Extracted from text ... Number 46 - Part 5 P van Rensburg Investment Basics: XXXIV The arbitrage pricing theory Introduction The APT was developed by Stephen Ross in the early 70s and first published in 'The Arbitrage Theory of Capital Asset Pricing' (1976). The APT is based on fewer and less restrictive assumptions than the more familiar capital asset pricing model (CAPM) of Sharpe (1964), Lintner (1965) and Mossin (1966). It is also a more general model than the CAPM allowing for more than one risk factor to underlie stock returns. However, the primary challenge in applying the APT is discerning the identity of ..

Kapitalkosten der Banken / Capital Costs of Banks

Zusammenfassung Wir wenden das Wicksell-Tobin Investitionsmodell, ergänzt durch die capital asset pricing Theorie, zur Ableitung der Kapitalkosten der Banken an. Im Gegensatz zum in der Literatur üblichen Verfahren arbeiten wir heraus, daß die Banken indirekt Kapitalgüter erwerben, wenn sie Unternehmen Darlehen gewähren. Zwei wichtige Ergebnisse folgen logischerweise. Erstens, unkritische Anwendung des capital asset pricing Modells auf die Bankenindustrie führt zu tautologischen Ergebnissen. Zweitens, der duale Charakter der Kapitalbewertungen in der Form des Marktwertes und der Reproduktionskosten des Kapitals führt uns zu Vorbehalten hinsichtlich des Bilanzbewertungsprinzips marking to market. Bewertung zu Wiederbeschaffungskosten verhindert, daß Banken während Aktienhaussen Geschäftsdarlehen aufgrund aufgeblähter Marktwerte gewähren. Unser vorgeschlagener Bewertungsgrundsatz dürfte zu größerer Stabilität des Bankensystems beitragen.

Growth, Value, Good, and Bad

The growth-value and small-large scales are popular, but they suffer from two deficiencies: They are not grounded in theory, and they clear definition. Shefrin and Statman offered a remedy in a theory in which the quality scale-the scale that separates companies from bad-plays a central role. Here, the ratings in the Fortune survey of company quality are used as direct measures of perceptions of company quality and a proxy for the Fortune quality ratings is constructed from the BARRA, Inc., list of company characteristics. This quality scale has applications in style selection and style rotation. Categorizing companies along the growthvalue and small-large scales is now a common practice. Both scales are imperfect measures of quality, the scale that separates companies perceived as good from those perceived as bad. Good companies have such characteristics as management and products and services. The growth-value and small-large scales have gained widespread use because empirical evidence, such as that presented by Fama and French, shows significant differentials in stock returns along these scales.1 The growth-value and small-large scales have two deficiencies, however, one related to of theoretical foundation and one related to ambiguity in measurement and application. Black noted that no theory underlies the return differentials along the growth-value and small-large scales.2 Discussing the Fama and French findings, Black wrote lack of theory is a tipoff: watch out for data mining (p. 9). As to the measurement issue, no general agreement exists about the characteristics that distinguish from value. Some analysts use book-price ratios, others use earnings-price ratios, and still others use dividend yield. Moreover, the terms growth and often are robbed entirely of meaning. Bogle reported that, as of the end of 1992, Philip Morris Companies was the largest holding of both and value mutual funds.3 As to size, Chan and Chen point out that the distinction that matters is not the distinction between small and large companies but the distinction between financially distressed and financially healthy companies.4 Moreover, although size is most often measured as market value of equity, measures such as book value of assets are also used. Shefrin and Statman offered a remedy for the theoretical deficiency of the growth-value and small-large scales within a behavioral capital asset pricing model.5 Asset prices in the behavioral capital asset pricing theory are the outcome of an interaction between two kinds of traders-information traders and noise traders. Information traders know the relationship between characteristics of companies and the return distributions of the stock of these companies. In contrast, noise traders make systematic errors as they assess the relationship between characteristics of companies and the return distributions of the stocks of these companies. The error that is relevant here is representativeness, a cognitive heuristic described by Tversky and Kahneman.6 The error manifests itself in the belief that stocks are stocks of companies. Statman and Shefrin provide direct evidence that, on average, investors indeed believe that stocks are stocks of compa7 nies.

Behavioral Capital Asset Pricing Theory

This paper develops a capital asset pricing theory in a market where noise traders interact with information traders. Noise traders are traders who commit cognitive errors while information traders are free of cognitive errors. The theory includes the determination of the mean-variance efficient frontier, the return on the market portfolio, the term structure, and option prices. The paper derives a necessary and sufficient condition for the existence of price efficiency in the presence of noise traders and analyzes the effects of noise traders on price efficiency, volatility, return anomalies, volume, and noise trader survival.

The Inconsistency of Land Values, Land Rents, and Capitalization Formulas

AbstractThis paper examines relationships that exist between farm income, land values, and capital asset pricing theory. Using two commonly referenced data sets, it is shown that land prices and land rents do not have the same time‐series representations, a necessary condition for the simple capital asset pricing theory to hold. This suggests that a fundamental rethinking of the way in which land prices are viewed and modeled is needed. More complex models that allow for rational bubbles, risk aversion, and future shifts in government policy or commodity prices may be required.

A Portfolio Diversification Model of Alliances

The theory of finance demonstrates that diversified investment portfolios produce superior combinations of risk and return, and that investors may choose a portfolio reflecting their preferred mix of risk and return. These techniques may be applied to military alliances. The rate of return and risk of an ally follows a positive linear relationship, as predicted by capital asset pricing theory. Random diversification of allies will, as with investment portfolios, reduce the country-unique components of alliance risk toward that which is inherent in the system as a whole. Some alliances will be more efficient at producing greater return and lower risk. The most efficient alliances will be those in which variations in ally effort move in opposite directions. Development of the demand side of portfolio analysis may predict which alliances are optimal, and therefore most likely to form. These principles are applied to the Triple Entente and Triple Alliance between 1879 and 1914. It is suggested that the Entente had superior efficiency characteristics and that ally choices were consistent with demand patterns.

Inventory management under uncertainty: A financial theory for the transactions motive

AbstractThis paper examines the effects of risk aversion and output market uncertainty on optimal inventory policy decisions for a transactions demand for inventory using the capital asset pricing theory. The paper shows that (1) the optimal order quantity of the risk‐adjusted value‐maximizing firm is smaller than that of the expected‐profit‐maximizing one and (2) the greater the firm's output market uncertainty, the smaller its optimal order quantity, where the output market uncertainty is defined as the relative volatility of the demand for the firm's output.

Commodity Contracts and Common Stocks as Hedges against Relative Consumer Price Risk

Evidence provided here suggests that investors could have identified, ex ante, portfolios that hedge against uncertainty in the prices of three major categories of consumption: food, shelter, and transportation. This finding has implications for the practical impor? tance of multi-period capital asset pricing theories that assume investors can identify such hedge portfolios. The study also provides some surprising evidence about the usefulness of common stocks and commodity futures contracts in hedging against specific price infla? tion. Certain combinations of common stocks serve as effective hedges, but combinations of commodity futures contracts contribute nothing to hedging ability.

The Market Model and Capital Asset Pricing Theory: A Note

The Market Model and Capital Asset Pricing Theory: A Note

The Market Model and Capital Asset Pricing Theory: A Note

ABSTRACTThis note shows that a linear market model is sufficient to derive a linear relationship between beta and expected return. Furthermore, the slope of the relationship will be identical with that of the Capital Asset Pricing Model if the return on the market portfolio is normally distributed. However, results from characterization theory suggest that the linear market model assumption is close to that of multivariate normality.

EVIDENCE ON THE EXISTENCE OF COMMON STOCK INFLATION HEDGES

AbstractPrevious researchers have been unable to identify (on an ex ante basis) inflation hedge portfolios consisting of common stocks. This study demonstrates a procedure for forming common stock portfolios that offer returns that vary positively with unexpected inflation. The strategy could have been used to hedge against purchasing power risk during the 1974–1979 period. In addition to its practical value, the research has important implications for capital asset pricing theory since the existence of hedge portfolios is a necessary condition for the superiority of the multi‐period CAPM over the single‐period models.

STOCHASTIC COST‐VOLUME‐PROFIT ANALYSIS IN A COMPETITIVE OLIGOPOLY

ABSTRACTPrevious stochastic cost‐volume‐profit (CVP) models have assumed that the firm was operating under either perfect competition or monopolistic conditions. This paper presents a stochastic CVP model applicable to oligopolistic competition. Each firm is assumed to maximize a linear function of the expected value and the standard deviation of its random profits. The result is a game‐theoretic model that is solved using the concept of a Nash equilibrium. The results of the model are used to examine a firm's competitive strength. The model can be easily modified to accommodate a measure of risk based on the capital asset pricing theory.

Investment Decisions under Uncertainty: Application of Estimation Risk in the Hillier Approach

In a seminal paper in 1963, Frederick S. Hillier alerted the finance community to the importance of including probabilistic information in the process of investment decision-making [4]. The method proposed and demonstrated by Hillier introduced the use of additional information regarding the probability distributions governing three measures of investment merit: present worth; internal rate of return; and uniform annual cost. He showed that by assessing investment merit only on the basis of a measure of central tendency, crucial information regarding dispersion, hence risk, was ignored and investments were not evaluated accurately. By incorporating the amount of risk involved in terms of the probability distribution of the present worth, the internal rate of return, or uniform annual cost, a firm's management can make more sound decisions regarding risky investment proposals. Since this important paper was published, a virtual revolution has occurred in finance, particularly in the area of risk assessment. Indeed, under modern capital asset pricing theory, the dispersion in the probability distribution of future cash flows is an irrelevant statistic. Instead, as the theory goes, a project's systematic risk, as indexed by its “beta,†is the only relevant measure of risk. This disparity between modern capital asset pricing theory and the type of analysis that follows from the Hillier approach will be addressed in detail in Section III. We will show that under conditions in which dispersion is regarded as the relevant measure of risk, the Hillier approach provides a reasonable approximation of the dispersion arising from the multiperiod framework.

EVIDENCE ON THE EXISTENCE OF COMMON STOCK INFLATION HEDGES

Previous researchers have been unable to identify (on an ex ante basis) inflation hedge portfolios consisting of common stocks. This study demonstrates a procedure for forming common stock portfolios that offer returns that vary positively with unexpected inflation. The strategy could have been used to hedge against purchasing power risk during the 1974-1979 period. In addition to its practical value, the research has important implications for capital asset pricing theory since the existence of hedge portfolios is a necessary condition for the superiority of the multi-period CAPM over the single-period models.