...the late 1970s. The second academic strategy DFA used was the Book to-Market effect based on the finds of Fama/French1992 paper titled “The Cross-Section of the Expected Stock Returns”. In 1993 Fama/French expanded the research in the a titled “Common Factors in the Expected Returns of Stocks and Bonds” that is known as the “Fama-French Three-Factor Model” Studying the company’s size or the book-to-market ratio may shed light on exposure to sources of systemic risk not captured by the CAPM beta, Fama and French developed the Three Factor Model believing that small stocks may be more sensitive to changes in business conditions and that these variables may capture sensitivity to macroeconomic risk factors. Also, using international data collected by Morgan Stanley Capital International, Fama and French found that high book-to-market stocks outperformed low in almost every country studied. Fama and French also found that in certain years value portfolios were outperformed by growth portfolios across a wide array of countries. Investor cannot expect to lower their risk by diversifying their investments in different countries, which also confirms the belief that value stock is risky. Based on the high level of correlation between value-growth portfolios, DFA introduced international value funds. 2. What do these findings imply for CAPM and EMH? The finds of Fama and French imply that CAPM measure of risk, “beta”, was inaccurate. CAPM was based on the idea that investors...
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...The Fama and French 3-Factor Model (Fama and French 1993) is used in asset pricing and portfolio management to describe stock returns. Unlike the CAPM, which uses only the market risk factor, in the Fama and French Model, two more factors are identified that cause stocks to do better than the market as a whole – the size factor and the value factor. This paper will first describe the methodology behind the size and value factor calculations. We will then discuss possible explanations as to why the two factors explain stock returns. Finally, we determine on the basis of academic evidence whether the two factors capture systematic risk. The three-factor model is mathematically expressed as follows: Where: ------------------------------------------------- r = portfolio expected return ------------------------------------------------- Β3 = “three factor” beta (conceptually analogous to the CAPM beta but not equal to it due to the presence of the two other coefficients in the regression) ------------------------------------------------- (Km- Rf) = market risk premium ------------------------------------------------- bs = sensitivity of expected return to size factor ------------------------------------------------- SMB = Small (market capitalisation) minus big ------------------------------------------------- bv = sensitivity of expected return to value factor HML = high (book to market ratio) minus low Fama and French (1992a) found that the historical-average...
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...Journal of Financial Economics 49 (1998) 283—306 Market efficiency, long-term returns, and behavioral finance Eugene F. Fama* Graduate School of Business, University of Chicago, Chicago, IL 60637, USA Received 17 March 1997; received in revised form 3 October 1997 Abstract Market efficiency survives the challenge from the literature on long-term return anomalies. Consistent with the market efficiency hypothesis that the anomalies are chance results, apparent overreaction to information is about as common as underreaction, and post-event continuation of pre-event abnormal returns is about as frequent as post-event reversal. Most important, consistent with the market efficiency prediction that apparent anomalies can be due to methodology, most long-term return anomalies tend to 1998 Elsevier Science S.A. All rights disappear with reasonable changes in technique. reserved. JEL classification: G14; G12 Keywords: Market efficiency; Behavioral finance 1. Introduction Event studies, introduced by Fama et al. (1969), produce useful evidence on how stock prices respond to information. Many studies focus on returns in a short window (a few days) around a cleanly dated event. An advantage of this approach is that because daily expected returns are close to zero, the model for expected returns does not have a big effect on inferences about abnormal returns. * Corresponding author. Tel.: 773 702 7282; fax: 773 702 9937; e-mail: eugene.fama@gsb.uchicago. edu. The comments of Brad Barber, David...
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...Journal of Financial Economics 49 (1998) 283—306 Market efficiency, long-term returns, and behavioral finance Eugene F. Fama* Graduate School of Business, University of Chicago, Chicago, IL 60637, USA Received 17 March 1997; received in revised form 3 October 1997 Abstract Market efficiency survives the challenge from the literature on long-term return anomalies. Consistent with the market efficiency hypothesis that the anomalies are chance results, apparent overreaction to information is about as common as underreaction, and post-event continuation of pre-event abnormal returns is about as frequent as post-event reversal. Most important, consistent with the market efficiency prediction that apparent anomalies can be due to methodology, most long-term return anomalies tend to disappear with reasonable changes in technique. 1998 Elsevier Science S.A. All rights reserved. JEL classification: G14; G12 Keywords: Market efficiency; Behavioral finance 1. Introduction Event studies, introduced by Fama et al. (1969), produce useful evidence on how stock prices respond to information. Many studies focus on returns in a short window (a few days) around a cleanly dated event. An advantage of this approach is that because daily expected returns are close to zero, the model for expected returns does not have a big effect on inferences about abnormal returns. * Corresponding author. Tel.: 773 702 7282; fax: 773 702 9937; e-mail: eugene.fama@gsb.uchicago. edu. The comments...
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...as well as the CAPM model conditional on segregating positive and negative market risk premiums with time varying beta (Model IV). Empirical results indicate that both the standard CAPM models (Model I and Model II) are statistically insignificant. However, the CAPM models conditional on segregating positive and negative market risk premiums (Model III and Model IV) are statistically significant. In addition, this study also discovers that time varying beta provides better explanatory power. Then from the literatures that i have gone through, it can be concluded that there is no one model that can claim to have the absolute ability to predict the expected stock return. While some researchers are questioning CAPM and in favor of Fama and French (1993) three factors model, there are studies that supported the performance of the CAPM model ( market risk, size and ratio of book-to-market value of equity, expected return ). They found that return is more precisely estimated by model consisting of this three factors. There are also researchers that question the use of either model for estimation of individual expected stock returns such as Bartholdy...
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...Name: XXXXXX Ahmed XXXXXX Course: XXXXX (Foundation of Financial Analysis and Investment (A) Course: MSC Finance Std: xxxxxxxxx Introduction Asset pricing models are very useful tools in calculating the risk and their respected return for the investors and they are being widely used by financial analyst. From different theories we can determine the value of assets into three steps i.e., Expected Cash Flow, number of periods and the expected rate of returns. Investors have several questions before investing his money in any stock or in any other commodity that is what should be the accuracy of prices of selling or buying the stocks, what could be the risk, what are the factors should be considered that ignores uncertainty and the expected returns of the stock. The Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Theory (APT) both are well known pricing model determines the risk factor for analyzing the appropriate returns for the investors in their own unique ways. CAPM model uses the whole market environment as one factor but on the other hand APT uses five different economics factor which is more detailed in describing risk which accelerates for these factors. The adoption of CAPM is in practice but other hand its various criticisms are documented on it as well and academics are working on the new approaches of it such as APT and others is discussed in later paragraphs. In this assignment I will discuss the assumptions of CAPM and APT model and their...
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...well-documented asset pricing factors into consideration. The results are robust to adding portfolio residuals and higher moment factor in the factor models. The results are also robust to seasonality, and conditional-market tests. We also compare alternative factor models and find that the liquidity four-factor model (market excess return, size, book-to-market ratio, and liquidity) is the best model to explain stock returns in the Hong Kong stock market, while the momentum factor is not found to be priced. Ó 2011 Elsevier B.V. All rights reserved. Article history: Received 10 June 2010 Accepted 17 January 2011 Available online 22 January 2011 JEL classification: G12 G15 Keywords: Liquidity Asset pricing Hong Kong stock market Factor model Fama French three factors Higher moment Momentum 1. Introduction Investors face liquidity risk when they transfer ownership of their securities. Therefore, investors consider liquidity to be an important factor when making their investment decisions. Amihud and Mendelson (1986) find a positive return-illiquidity relation. Since that study, many other researchers continue to investigate the return-illiquidity (liquidity) relation, but evidence over the past two decades is generally inconsistent and...
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...------------------------------------------------- Case Study-Dfa Dimensional fund Advisors Submitted By:- Azouaou Dahmoune Drishti Oza Jeffery Meeks Kesha Patel Urvi Jain Submitted By:- Azouaou Dahmoune Drishti Oza Jeffery Meeks ...
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...Would you invest in DFA? Yes due to steady returns provided by the company and as investors are generally past performance chasers, one has no reason not to invest in DFA. The company was founded on a sound investment style based on its core belief in sound academic research, passive fund management. Until almost the end of the 20th century DFA had found a way to make money actively with a passive investment strategy. But looking forward, according to me it needs to evolve with the times and look for questions regarding its own strategy and its evolution with the times and the questions facing the financial future. As highlighted by the boom in the I.T sector towards the end of the last century that DFA missed out on completely, DFA on principle is always poised to miss out on new technology companies, as they intrinsically have low book to market value. Also my another objection to DFA’s selection of small cap stocks only is that these category of companies are among the worst hit companies during a financial crisis because of their limited access to credit and most of these companies don’t survive a major recession. Even some proponents of the efficient market hypothesis have argued that due to DFA and similar companies investing in this particular style, this style’s edge had been eroded. Lastly many prominent academicians and financial institutions have called into question the efficacy of the efficient market theory due the financial bubble created in...
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...selling for less than their intrinsic value’ and after purchasing, waits for market recognition that corrects this discrepancy. Athanassakos (2011b) has illustrated that a search for undervalued stocks is the initial process undertaken. He maintains that these stocks tend to be ‘avoided by large institutional investors’ and are not the ‘glamour stocks everyone wants to own’. Graham (1973, p. 211) describes two methods of searching for fundamentally undervalued stocks; companies selling at a low price to earnings ratio (PER) and companies selling under their net current asset value, otherwise known as a low price to book value (P/BV). Companies matching these criteria are widely described as value stocks (Athanassakos 2011b; Basu 1977; Fama & French 1992; Lakonishok, Shleifer & Vishny 1994; La Porta et al. 1997). There is extensive academic research documenting that value stocks produce higher...
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...Journal of Accounting and Economics 55 (2013) 206–224 Contents lists available at SciVerse ScienceDirect Journal of Accounting and Economics journal homepage: www.elsevier.com/locate/jae Cost of capital and earnings transparency$ Mary E. Barth a,n, Yaniv Konchitchki b, Wayne R. Landsman c a Graduate School of Business, Stanford University, Stanford, CA 94305, USA Haas School of Business, University of California at Berkeley, Berkeley, CA 94720, USA c Kenan-Flagler Business School, University of North Carolina at Chapel Hill, Chapel Hill, NC 27599, USA b a r t i c l e in f o abstract Article history: Received 22 December 2008 Received in revised form 19 November 2012 Accepted 23 January 2013 Available online 1 February 2013 We provide evidence that firms with more transparent earnings enjoy a lower cost of capital. We base our earnings transparency measure on the extent to which earnings and change in earnings covary contemporaneously with returns. We find a significant negative relation between our transparency measure and subsequent excess and portfolio mean returns, and expected cost of capital, even after controlling for previously documented determinants of cost of capital. & 2013 Elsevier B.V. All rights reserved. JEL classification: D8 G12 M4 M41 Keywords: Cost of capital Earnings transparency 1. Introduction This study provides evidence that firms with more transparent earnings enjoy a lower cost of capital. Firms with more transparent earnings are those whose earnings...
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...EMH, Random Walk Theory proposes market prices abide no pressure from past-price movements thus pursue a random course, making impossible to forecast future-price movements as they are an independent of past-prices. Fama (1970) establish three-level grading system portraying degree of market efficiency, based on investment approach endowing abnormal returns: Market anomalies are inconsistent with EMH and a consequence of deviations and incomprehensible patterns in smooth running of stock markets. Anomalies are statistically considerable and additionally proffer investors with risk adjusted economic returns. Once documented and scrutinized in literature, anomalies tend to disappear, overturn, or attenuate; doubting their subsistence in past, as being statistical irregularity, or have been arbitraged away. This essay will begin by defining limitations of CAPM and introduce three-factor model. Additionally, it will discuss the fundamental anomalies (Value and Size effects), calendar anomalies (January, Weekend and Time-of-the-month effects) and Technical anomalies (Momentum and Reversal effects) in developed and emerging markets. Lastly, it will conclude if reliance over such effects would generate consistent abnormal returns or not. CAPM and Fama and French: Fundamental Anomalies: Size Effect: Banz (1981) and Reinganu (1981) illustrate an inverse relationship between security returns and market value of a...
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...FINC3017 Investments and Portfolio Management Essay: Market Efficiency and Anomalies Topic：Stock price momentum: Jegadeesh and Titman (1993) Momentum anomaly and EMH Anomaly is a stock return deviation that challenge efficient market hypothesis (EMH). Jegadeesh and Titman (1993) theorise price momentum anomaly in the stock market for the first time. It contradicted to efficient market hypothesis thereby is widely debated. EMH states that no consistent excess return can be achieved since security prices fully reflect all available information (Fama 1970). Therefore, future prices cannot be predicted through technical analysis of past prices. If the hypothesis is true, passive investment strategy ought to be taken, because it is impossible to get abnormal return by aggressive trading. However, Jegadeesh and Titman show that stocks performed well over the previous 3 to 12 months tend to continue to perform well over 3 to 12 months holding periods. Buy past winners and short past losers earned statistically significant positive return of averaging 12.01% per year. Predictable price patterns and excess returns contradict the efficient market hypothesis. Investors and fund managers perform actively in pursuing abnormal profits. Literature review and the reason of anomaly A large number of literatures illustrate that momentum anomaly exist. Some important literatures are Chan, Jegadeesh and Lakonishok (1996), Conrad and Kaul (1998) and Moskowitz and Grinblatt (1999). Lee and Swaminathan...
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...Why Does an Equal-Weighted Portfolio Outperform Value- and Price-Weighted Portfolios March 2012 Yuliya Plyakha Raman Uppal Goethe University Frankfurt EDHEC Business School Grigory Vilkov Goethe University Frankfurt Abstract We compare the performance of equal-, value-, and price-weighted portfolios of stocks in the major U.S. equity indices over the last four decades. We find that the equal-weighted portfolio with monthly rebalancing outperforms the value- and price-weighted portfolios in terms of total mean return, four factor alpha, Sharpe ratio, and certainty-equivalent return, even though the equal-weighted portfolio has greater portfolio risk. The total return of the equal-weighted portfolio exceeds that of the value- and price-weighted because the equal-weighted portfolio has both a higher return for bearing systematic risk and a higher alpha measured using the four-factor model. The nonparametric monotonicity relation test indicates that the differences in the total return of the equal-weighted portfolio and the value- and price-weighted portfolios is monotonically related to size, price, liquidity and idiosyncratic volatility. The higher systematic return of the equal-weighted portfolio arises from its higher exposure to the market, size, and value factors. The higher alpha of the equal-weighted portfolio arises from the monthly rebalancing required to maintain equal weights, which is a contrarian strategy that exploits reversal and idiosyncratic volatility...
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...compared to low risk stocks, i.e. high risk stocks should cluster in the tails of the cross-sectional return distribution. Building on this intuition, we test the risk interpretation of the CAPM’s beta by examining if high beta stocks are more likely than low beta stocks to experience either very high or very low returns. Our empirical results indicate that beta is a strong predictor of large positive and large negative returns, which confirms that beta is a valid empirical risk measure and that researchers should use beta as a risk control in empirical tests. Further, we show that because the relation between beta and returns is U-shaped, i.e. high betas predict both very high and very low returns, linear cross-sectional regression models, e.g. Fama-MacBeth regressions, will fail on average to reject the null hypothesis that beta does not capture risk. This result explains why previous studies find no significant cross-sectional relation between beta and returns. Key words: Market beta; New research method; Empirical accounting and finance research. PAWEL BILINSKI (pawel.bilinski.1@city.ac.uk) and DANIELLE LYSSIMACHOU (danielle.lyssimachou.1@city.ac.uk) are Associate Professors of Accounting at Cass Business School, City University London. The authors would like to thank Michael Brennan, Paul Griffin, Gilad Livne and Peter Pope for helpful comments. INTRODUCTION The capital asset pricing model (CAPM) of Sharpe (1964) and Lintner (1965) lies at the heart of empirical accounting...
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