Two Pillars of Asset Pricing (Fama, 2014)

Question 1

What is the central question of the “Two Pillars of asset pricing”?

Answer 1

Whether asset prices reflect all available information - what Fama has labeled the efficient markets hypothesis.

Question 2

What are forms of market efficiency?

Answer 2

1. weak: prices reflect only past info (impossible beat the market using technical analysis)
2. Semi-strong: prices reflect all publicly-available info (past and present)
3. Strong: prices reflect all available information (public and private) (Fama wrties about it)

Question 3

What is the main question of all?

Answer 3

Are markets efficient?

Question 4

What is joint hypothesis problem?

Answer 4

One needs to specify what market is supposed to do to check it if it does that. In test rejection is possible:
a)market tested is indeed inefficient
b) te chosen asset pricing model is bad

Question 5

What are the implications for future performance on average from stock splits?

Answer 5

All implications for the future performance of a company are incorporated in stock prices in the months leading up to the split, with no reaction thereafter.

Question 6

Why over short periods, equilibrium expected returns is relatively unimportant?

Answer 6

Because the reaction is typically much larger than short-horizon expected returns (joint hypothesis problem is not a problem).

Question 7

Does JHP becomes relevant again over longer periods?

Answer 7

Expected returns are larger than the price of effect of a studied event.

Question 8

If EMH works, then what is the best way to predict future inflation?

Answer 8

Fischer hypothesis that bond interest rate incorporates expected return and the best possible forecast of inflation rate. Previous interest rates are the best way to forecast future rates.

Question 9

Does JHP affect the Fischers hypothesis on longer-term returns? works for all except stocks.

Answer 9

JHP is back, expected stock returns may vary in time and the assumption that holds for bonds and real estate does not hold for stocks.

Question 10

Why expected return likely varies in time for stocks? (early literature assumes constant)

Answer 10

Because both - the underlying risk and willingness to bear the risk - for investors are likely to be dynamic.

Question 11

What is default spread on bonds by Fama and French?

Answer 11

Difference between the yields on long-term bonds of high and low credit risk.

Question 12

What is term spread?

Answer 12

The difference between long-term and short-term yields on high grade bonds.

Question 13

What default spread on bonds and term spread predict?

Answer 13

It predicts stock returns (so does the dividend yield)

Question 14

With what default spreads and dividend tields are related to? What about term spreads?

Answer 14

Default spreads and dividend yields are related to long-term business conditions, while term spreads are strongly related to short–term business cycles.

Question 15

In bubble, with what stock returns are somewhat predictable?

Answer 15

From dividend yields and interest rates, but there is no statistically reliable evidence that expected stock returns are sometimes negative.

Question 16

How policy statements seem to define “bubble”?

Answer 16

Bubble is an irrational strong price increase that implies a predictable strong decline, but there are no evidence that declines are ever predictable.

It is a guessing game and successful forcasters emerge grom ex post selection bias.

Question 17

Why it seems that large swing in stock prices are responses to large swings in real activity?

Answer 17

With stock prices forecasting future real activity.

Question 18

What are 2 models of asset pricing?

Answer 18

1. Standard asset pricing models: work forward from assumptions about investor tastes and investment opportunities, then test the model.
2. Empirical models: backward procedure - take as given a pattern in average returns and propose models to capture them.

Question 19

Does CAPM hold?

Answer 19

Prediction that beta is the only factor necessary to explain cross-section of expected returns simply does not hold,

Question 20

How Three-Factor Model performs?

Answer 20

Does well on anomalies associated with size, sales growth, and price ratios, but falls with other anomalies.

Question 21

What is the main challenge to EMH as such.

Answer 21

Momentum