Single Index Model & CAPM Flashcards
what is the one factor that the single index model believes is the common influence to stocks
market index
what does alpha represent in the single index model
unique risk
what does beta represent in the single index model
universal risk
do you need 1 alpha for all the assets or one for each
one for each
do you need 1 bet for all the assets or one for each
ONE for each
why is single index model more efficient than markowitz mode
no pairwise covariance matrix
just look at how each individual asset through their common relationship with the market, ignoring their independent relationships with each other
if the alpha is positive should you long or short
long
if the alpha is negative should you long or short
short
what is used to estimate beta in excel
slope function of historical data
how to pick amount of historical data to use to predict beta
short period = more accurate
but could also be affected by special events in short period
if alpha is higher should weight be higher or lower
higher
if alpha is lower should asset weight be higher or lower
lower
drawbacks to the single index model
over simplifies the world
morkowitx will include correlation and will place smaller weight of correlated assets
single index model doesn’t know correlations so could actually pick highly correlated stock
what is alpha in CAPM
0
what are the restrictive assumptions of the CAPM model
no transaction costs
assets are infinitely divisible
no personal income tax
an individual cannot affect the price of stock
investors make rational decisions
unlimited shorts are allowed
unlimited borrowing allowed
all assets can be sold and bought
examples of personal income tax
income and capital gains tax
can an individual affect the price of a stock
yes large transactions tend to move the market
well known investors can influence others
what does SML ctand for
security market line
what does SML graphically represent
CAPM
if an asset sits on the SML it is ..
well behaved
in order for the asset to sit on the SML what has to hold
the 10 unrealistic assumptions
where is capm used
academic world
investment industry
corporate world
how do we know the capm is popular in investment industry
when you google a share price it will also show you the beta
how is CAPM used in the corporate world
with dividend dscount model
get the average of the twoq
why is CAPM Attractive
simplicity
less estimation errors
underlying reason for CAPM
you will not be rewarded for non systematic risk
examples of systematic risk
interest rates
inflation
economic cycles
political uncertainty
widespread national disasters
examples of multi factor models
forecasts for GDP, interest rates, energy prices
