4 Investment theory Flashcards
What does CAPM stand for?
Capital asset pricing model
What is the Fama & French model?
A multi-factor model that expands on CAPM
What extra factors does Fama & French take into account?
- Company size (small cap > large cap)
- Value (value stocks > growth stocks)
Does Fama & French prefer more or less volatile investments?
More volatile
What is the EMH?
Efficient market hypothesis
What are the three forms of EMH?
- Weak-form efficiency
- Semi-strong efficiency
- Strong-form efficiency
What does weak-form efficiency discount?
Technical analysis of historical price + trading volume data
What does semi-strong efficiency discount?
All public information, including fundamental analysis of the underlying company’s performance
What is one limitation of the EMH?
Investors do not think or value investments rationally
What are examples of more efficient markets?
Government bonds, large cap stocks
What are examples of less efficient markets?
Small cap stocks, private equity
What is the basic idea of prospect theory?
People care more about losses than gains, leading to loss aversion
What is loss aversion?
Taking greater risks to avoid loss, e.g. holding onto losing investments too long
What are some behavioural finance biases?
- Overestimate your own judgement & influence
- Underestimate likelihood of bad outcomes
- Overvalue recent experience
What is a limitation of behavioural finance?
It can explain anomalies but not predict them
