3-228-07
Albert Lee Chun
Todays Lecture
Single Factor Model
Multifactor Models
Fama-French
APT
Portfolio Management
Alpha
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Alpha
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ri E (ri ) iF ei
Albert Lee Chun
Portfolio Management
ri E (ri ) iF ei
i = index of a securitys particular return to the factor
F= some macro factor; in this case F is unanticipated
movement; F is commonly related to security
returns
Assumption: a broad market index like
the S&P/TSX Composite is the common factor
Albert Lee Chun
Portfolio Management
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Let:
Ri = (ri - rf)
Rm = (rm - rf)
Risk premium
format
Ri = i + iRm + ei
The above equation regression is the single-index
model using excess returns.
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2
M
i i
(ei)
i2 = total variance
i2 m2 = systematic variance
2(ei) = unsystematic variance
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P 1N
P 1N
eP 1
2
p
i 1
N
i 1
N
i 1
2
P2 M
2 (e P )
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.. .
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SCL
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Excess returns
.on. market index
Ri = i + iRm + ei
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Multifactor Models
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Multifactor SML
E(r) = rf + GDPRPGDP + IRRPIR
GDP = Factor sensitivity for GDP
RPGDP = Risk premium for GDP
IR = Factor sensitivity for Interest Rates
RPIR = Risk premium for GDP
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Multifactor Models
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APT
Assumptions:
1. There are sufficient number of securities to diversify
away idiosyncratic risk
2. The return on securities is a function of K different
risk factors.
3. No arbitrage opportunities
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APT
1.
2.
3.
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rP E(rP ) PF eP
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Well-diversified portfolio
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Single Stocks
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D
C
Risk Free = 4
.5
1.0
Beta for F
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Disequilibrium Example
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E (rP ) rf P ( Rm rf )
This is CAPM!
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A Multifactor APT
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9-37
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In theory, the APT supposes a stochastic process that generates returns and that may be
represented by a model of K factors, such that
Bij = Sensitivity of the reutrn of the ith stock to the jth risk factor
Similar to CAPM, the APT assumes that the idiosyncratic effects can be diversified
away in a large portfolio.
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Multifactor APT
APT Model
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Risk Premium
.06
.04
.02
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Example 9.4
Suppose that: E(RA) = 12% < 13%
Portfolio Q
Ponderation B1 = .5: facteur portefeuille 1
Ponderation B2 = .75: facteur portefeuille 2
Ponderation 1- B1 B2 = -.25 : rf
E(Rq ) = 12%
$1 x E(Rq) - $1x E(RA)=1%
There is a riskless arbitrage
opportunity of 1%!
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Next Week
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