Risk, Returns and Benchmarking Flashcards
3 methods of distinguishing asset pricing models
Np, Te, Aa
- Normative vs positive model (investors should behave VS do behave)
Markovitz portfolio theory vs Behavioral model
- Theoretical vs. empirical model (based on assumptions and logic about investor behavior vs historically observed investor behavior)
Investors maximize return based on mean variance analysis vs historically observed behavior
- Applied vs abstract (pragmatic vs unrealistic assumptions)
Asset pricing model
Describes relationship between risk and expected return.
Benchmarking
Identifying the appropriate index against which a portfolio’s performance can be evaluated. The appropriateness of the index depends on correctly matching the objectives and constraints of the index with that of the portfolio.
Cross sectional models, Time series models and Panel data sets
Cross sectional models describe behavior across many assets.for a single point in time.
Time series models describe behavior across time, for a single asset.
Panel data sets refer to data spanning multiple time periods and multiple assets.
Describe Fama-French Carhart four factor model
There is a 4th factor, UMD, the momentum factor.
M stands for minus. Up the most MINUS down the most during the prior year.
It is the difference in return for all 4 factors.
Describe Fama-French model
Empirical mutifactor (3 factor) model
Used in conventional equity investments.
E(Ri)-Rf = B1*(Rm-Rf)) + B2*E(SMB)) +B3*E(HML).
The 3 factors are mmb:
- market,
- market capitalization and
- book-to-market ratio.
SMB & HML are differences in returns.
Both SMB HML are hedger strategies, long small firms and short big firms; long high book to market firm and low book to market firms.
M stands for minus
Give examples of commonly used Multi-factor asset pricing models
a) Fama-French 3 factor model,
and b) Fama-French -Carhart 4-factor model.
How are indexes valued and give examples of common indexes
Value weighted.
MSCI World Index and Russell 2000 are popular equity benchmarks
Limitations of capm on AI
The 3 N’s.
Non-stationarity of returns (Mean and Variance does not remain constant through time)
Non-normality of returns
Non liquidity
Peer group
Group of funds with same objectives and constraints as the portfolio considered.
What are the 2 types of benchmarks?
Peer groups and Indices
- Peer groups (group of comparison funds with the same objectives and constraints to the fund under examination);
- Indices (portfolio of securities representing a particular market or a portion of it). MSCI World Index and Russell 2000 are popular equity benchmarks
What is a a cross sectional model? What is a time series model?
Cross-sectional models describer differences across subjects for a single point in time, for example explain how profits differed across 50 oil drilling projects last year.
Time series models describe differences across time for a single subject.
What is a multi factor asset pricing model?
It describes the relationship between expected return of assets and the asset’s exposure to multiple factors.
What is CAPM?
Cross-sectional equilibrium single factor asset pricing model that derives the expected return on a stock, given the expected return on the market portfolio, the stock’s beta coefficient, and the risk-free rate
What is meant by active return?
Difference between actual return and its benchmark
