The capital asset pricing model is a model that allows to determine the theoretical rate of asset returns required by an investor, given the asset systematic risk or market risk.

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how can we know the residual return will be uncorrelated with the market return

I was reading that if we know a portfolios beta we can break the excess return on that portfolio into a market component and a residual component. ...
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Excess, Residual and Active Return

in CAPM. What's the difference between these different types of returns? Active return Excess return Residual return
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41 views

Regressing using Fama-French portfolios with small amount of stocks

I'm doing some research for my thesis and I was wondering if it is possible to only use monthly stock price data for 22 stocks and construct Fama-French portfolios out of them and then regress? What ...
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143 views

Market returns below risk free rate

Let's say I'm using CAPM to estimate the cost of equity, so I need expected market returns for the calculations. The standard approach is simply to compute arithmetic mean of an index (or rather its ...
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1answer
64 views

Understanding CAPM, CML, and efficient portfolios

I'm trying to understand the CAPM model and how we can use it to understand efficient portfolios. Specfically, I'm trying to use the CML line (mapping expected returns and standard deviations of ...
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31 views

Monthly market value data of indices: where to get?

I am currently working on a paper related to portfolio optimization. As of this moment, I am considering to use a dataset consisting of the following indices: MSCI World MSCI Emerging Markets SP ...
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45 views

CAPM betas at different horizons

When taking capital budgeting decisions appropriate cost of capital should depend on the horizon of the investment. So the beta of a stock, i.e. it's covariance with the market should depend on the ...
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87 views

Correlation -1 and standard deviation [closed]

My book says that for a portfolio of two stocks: $\sigma_p = \sqrt{w_A^2 \sigma_A^2 + (1-w_A)^2 \sigma_B^2 + 2 w_A (1 - w_A) \rho_{AB} \sigma_A \sigma_B}$ Elsewhere it says that if the correlation ...
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167 views

Why are investors risk-averse?

In CAPM, we assume people are risk-averse and people get compensated for the systematic risk they suffer. The assumption that most people are risk-averse makes sense, but why are the rational ...
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58 views

Security Market Line & Required Rate of Return for Projects

A standard definition of the Security Market Line is as follows: The security market line ("SML" or "characteristic line") graphs the systematic (or market) risk versus the return of the whole ...
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66 views

Stock valuation/stock pitch and CAPM

If you were valuing a stock (say to pitch a stock for the buy side), you are looking for stocks that the market has mispriced. Your aim is to have a profitable long or short strategy. Can you use the ...
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46 views

CML, SML and Pricing

hi i have a confusion about what conclusion I can draw regarding the pricing from the Capital market line and security market line. As far as I know, if an asset that is lying below the SML is ...
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4answers
184 views

Intuition behind Fama-French factors

In the Fama-French 3-factor model the portfolio returns are explained by the market the SMB factor (Small [market capitalization] Minus Big) and the HML factor (High [book-to-market ratio] Minus ...
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73 views

Liquidity Adjusted Asset Pricing Model

I have a data set with 4000 companies and I have calculated a liquidity measure of each of the company in the dataset as Where, Turnover is the monthly average ratio of daily volume to shares ...
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1answer
82 views

How to get Correlation using Options data?

I can calculate the "Implied Beta" using implied volatility for the option stock, and implied volatility for the market (VIX). Is there any way to calculate also the correlation without performing a ...
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27 views

Change in portfolio when IPO announced

I'm wondering whether there would be a change to my answer of the change in portfolio when there is a new stock introduced. My investment strategy is to maximise expected return such that my standard ...
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2answers
80 views

Does anyone know where I can find a free efficient frontier tool, or an informative and legitamate/academic graph of the efficient frontier?

I'd like to build a portfolio based upon modern portfolio theory and I'd like to find a tool I can use to calculate the proper mix of asset classes. Can anyone help with this? I think a good ...
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34 views

Return, STD and CAPM based on Continuously compound return on daily prices

Mission: For some ETF, Get 1, 3, 5 years: Return STD CAPM parameters (alpha, beta) Reference if I calculated correctly: Yahoo finance performance & risk data Raw data: Daily adj. close ...
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133 views

Estimate Beta of CAPM from Implied Volatility?

In the CAPM theory Beta of asset $i$ are estimated in this way: $ \beta_i = \frac{\sigma_{im}}{\sigma^2_m} $ where $\sigma_{im} = \rho_{im} \sigma_i \sigma_m$ But all these data are historical data. ...
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109 views

Fundamental CAPM questions

A couple questions about the CAPM model: If I only know the riskfree rate and expected market return, how do I solve for $\beta$ ? Given the stock's variance, how do I solve the percentage of it ...
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35 views

Generalized method of moments concept in CAPM testing

In the course of my master thesis I’ve come across a paper by Carr and Wu (2009) where the authors evaluate whether returns on variance swaps can be explained by the simple CAPM. (really only market ...
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78 views

Risk-Free Rate In CAPM

Let's start out with the CAPM equation itself: $E(R_i) = R_{f1} + \beta_{i}(E(R_m) - R_{f2})$ Are there cases where one should choose a different $R_{f1}$ and $R_{f2}$ (Risk Free Rates Of Interest) ...
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29k views

How to calculate unlevered beta

I have derived a firm's cost of equity using the WACC formula (see here), which means that the cost of equity has factored in the firms' debt (i.e. levered beta) and now I need to calculate the firm's ...
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101 views

how negative rates (mr and rf) affect CAPM

I don't understand how the negative rates factor into this and what it means in the market ...
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4k views

What are the implication of a negative risk-free rate on SML?

What happens to the Security market line (within the CAPM model) when the risk-free rate turns negative?
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102 views

What do you do with low r-squared when calculating high-frequency beta

I am calculating a high-frequency beta. For example I have 90 days of data of the S&P and GOOGLE and I have 10-minute percent returns for each instrument. Each day has 34 10-minute percent returns ...
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113 views

Interpretation of the CAPM model under Stochastic Portfolio Theory framework

The CAPM under the Modern Portfolio Theory approach is given as: $$ R_i = \beta_i R_\pi $$ Where $R_\pi$ the portfolios expected excess returns Under the stochastic portfolio theory approach: $$ r_i ...
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105 views

Fit linear model to higher moments of CAPM

How can one fit a linear model to the higher moments of CAPM in R? Fitting a linear model to the second moment (classical CAPM) would be ...
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28 views

Intrepreting the Capital Market Line plot

I am looking at plots of the Security Market (SML) line and Capital market line (CML). The X axis is the beta for the SML and Standard deviation for CML; the y axis is labeled with excess return. ...
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81 views

Apply CAPM using returns on a foreign currency as the market returns

I want to analize Bitcoin returns using the CAPM. I was thinking if it makes sense to compare returns of (BTC/USD) against (EUR/USD), taking the latter as the market returns. However, since EUR is ...
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1answer
15 views

Measure difference between estimations and historic returns

For every day in a year, I have the return on an asset and the CAPM estimation for the return. I want to measure the average difference between the set of returns and set of estimations. So far, I ...
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2answers
3k views

Why do stocks with a negative beta return less than the risk free rate?

Let's say we have two stocks, Stock A and Stock B. Both of them have the same standard deviation $\sigma$, and therefore have the same risk. The only difference is that Stock A has a perfect ...
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CAPM - Beta of zero and its implications on diversification

I don't know if this is the right forum in which to ask this question, but here goes. I'm working through Luenberger's Investment Science. The form of CAPM model given in the book is $$\bar{r}_i - ...
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647 views

Is the CAPM beta equivalent to the coefficient estimate of an OLS regression?

The $\beta_i$ of an asset or portfolio is defined as its covariance with the market (which itself therefore has a beta of $\beta_m = 1$). The CAPM looks a lot like a simple linear regression model. Is ...
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Is CAPM a failure?

CAPM says that in order to generate high returns I need to take more systemic risk. But the ex-post results do not seem to validate this theory. There is a ETF SPHB - PowerShares S&P 500 High ...
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1k views

How to estimate market integration parameter in Singer-Terhaar model for E(r)?

Singer-Terhaar is part of CFA II and III curriculum. It estimates risk premium for some asset, traded at some local market, as weighted average of expected premiums for the case of (1) local market, ...
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435 views

Linear Model setup for Second-pass Regression

I'm confused on modeling the second pass regression given the beta's from the first pass. First-pass regression : $r_{it} - r_{ft} = a_{i}+b_{i}(r_{Mt}-r_{ft})+e_{it}$ For estimating this model (9 ...
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How to test the 5 Factor CAPM of Fama & French (2014)?

I would like to conduct a study testing the 5 factor CAPM, using UK stocks. Does anyone have any suggestions of how I can do this? Could this task be as simple as regressing average returns for a ...
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107 views

How to use WACC for investment?

How to use a value of WACC? I have calculated WACC of company to be 7%. What if company had smaller or bigger WACC? Which one would attract investment?
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64 views

How consequential are violations of the efficient diversification assumption of asset pricing models?

When using asset pricing models such as the CAPM or the Fama-French four factor model to determine the risk-adjusted return of a portfolio, does this strictly require efficient diversification of the ...
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544 views

Difference between CAPM and mean variance optimization

Is the mean variance optimization the same thing as the capital asset pricing model? Or is the mean variance only a part of CAPM?
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346 views

Validity of CAPM

I came across some literature regarding "Framing Theory" or "Prospect Theory", and the validity of CAPM. I was wondering if you could shed some light on a few questions I have in this regard: ...
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298 views

CAPM (SML) Problem

I got 1.3636 for beta for the problem below(165/121). But I became so unsure about the answer when I solved (c) because then the market risk becomes larger than the variance of Stock A. ...
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Question 1.18 from Hull's Financial Risk management CAPM

A portfolio manager maintains an active portfolio with beta of 0.2. Risk-free rate is 5% The market return for a particular year is -30% The fund produced a result of -10%. He claimed the return was ...
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803 views

Risk-Free Rate determinant in CAPM

I have trouble understanding what type of maturity to use when calculating CAPM. My professor uses the 3-Month risk-free rate to ...
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76 views

different amount of information on return correlations from shorter and longer periods?

I want to calculate annual excess returns on portfolios using monthly (total) returns for a CAPM (for the assets in the portfolio as well as for the benchmark), in order to have more information on ...
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2answers
107 views

Calculate alpha (CAPM) in “cross country-portfolio”

Assume I wanted to compute the alpha (in CAPM sense, i.e. $r_i - r_f = \alpha_i + \beta_i(r_m - r_f) + \epsilon_i$) of a stock. So I take, say, monthly returns of a stock $i$ for 1 year. Subtract the ...
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399 views

Beta arbitrage in CAPM

i'm following the "Computational Investing 1" course at Coursera.org, I was affascinated by the Beta arbitrage of CAPM Video: https://class.coursera.org/compinvesting1-002/lecture/view?lecture_id=119 ...
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493 views

annual excess returns from CAPM on monthly total returns

I want to calculate annual excess returns on portfolios using monthly returns for a CAPM (for the assets in the portfolio as well as for the benchmark), in order to have more information on the ...
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1answer
120 views

right benchmark for an incompletely diversified international portfolio (for a CAPM): MSCI World or MSCI ACWI IMI?

I want to calculate annual excess returns on portfolios using monthly returns for a CAPM (for the assets in the portfolio as well as for the benchmark), in order to have more information on the ...