These Effects Suggest That The Abnormal Risk-Adjusted Returns Are Predictable In Equity Markets

Submitted By cloud724
Words: 956
Pages: 4
Open Document
Homework 4
Chapter 11
7. These effects suggest that the abnormal risk-adjusted returns are predictable in equity markets, especially when findings are difficult to reconcile with the efficient market hypothesis.
a. P/E effect: some studies find that portfolios of low price-earnings (P/E) ratio stocks have higher returns than high P/E portfolios. The reason is that CAPM maybe not fully consider all the risk factors. If a firm believed risker, it may have a lower price, which lead to a higher P/E ratio.
b. Book-to-market effect: investors can earn excess returns by investing in companies with high book value to market value. Fama and French found that book-to-market ratios seem capable of predicting future returns because CAMP doesn’t include a risk factor reflected by book-to-market ratio.
c. Momentum effect: past performance of a stock is positively correlated with its future performance. Because investors are likely to underreact to new information, therefore if a stock did well in the past, it would keep doing well in the future. Some studies show that in momentum models, which included transaction costs, momentum traders are not likely to outperform the EMH strategy of buy and hold.
d. Small-firm effect: smaller firms produce higher returns than larger firms. Frpm 1926 to 2008 average annual returns are consistently higher on the small-firm portfolios. It is generally believed that small firms are risker than larger firms, so their perceived risk and return are higher than larger firms’. Another reason is the database doesn’t include the stock returns of those firms, which went bankrupt. Therefore this data has bias.

9. c. Because if the stock market is weakly efficient, there shouldn’t be a predictable pattern in returns.

14. d. Because there are semistrong-form efficient markets, information such as P/E ratio, recent price changes, is publicly known. Therefore it’s hard to earn abnormally high trading profits by using P/E ratios and recent price changes. On the other hand, if I have advance knowledge of an improvement in the management team which is not known by public, I can earn abnormally high trading profits.

19. a 1%+2*(1.5%-1%)=2%. Because the company won a $1 million lawsuit, which is 1% of initial equity, 2%+1%=3%. The total return should be 3%.

b. If the market had expected AmbChaser to win $2 million, the company’s nonsystematic return would be -1%. Therefore, 2%-1%=1%. The total return should be 1%.

Chapter 12
4. a. The principle of behavioral finance of overconfidence is most consistent with the investor’s statement. Even though he had been very satisfied with what he earned from Petrie stock over the past 2 years, he was too confident to make such a conclusion that the Petrie stock would continue to outperform in the future.

b. The principle of behavioral finance of mental accounting is most consistent with the investor’s statement, because the investor tended to separate his account into two accounts instead of considering the risk and return of whole investment. When he is considering the risk and return, he should include his “specific use money “ into the whole investment.

3.
(1a)
Book to market
Lo 10
5-Dec
Hi 10 α -0.000022
0.000013
0.000049
T stat
-2.4071
1.378872
3.10536026
P-value
0.0165
0.168651
0.00202619
β
0.011020
0.008932
0.009390
T stat
53.29625
41.7311
27.00226145
P-value
1.5E-191
2.7E-153
1.2387E-94

From this table, we can see that from low book to market ratio to high book to market ratio, the Alpha is growing, but the Beta has no trend. Most of the Alpha are significant. It is possible that CAPM beta not fully captured the size and relative value proxy for risks.

FF α β t Stat
P-value
Lo 10
0.000011

1.781527
0.075535
Mkt-Rf

0.009680
62.112982
3.0062E-216
SMB

-0.001564
-7.802259
4.69997E-14
HML

-0.005336
-23.069135
4.15258E-77

5-Dec
-0.000010

-1.126671
Show More

Related Documents: These Effects Suggest That The Abnormal Risk-Adjusted Returns Are Predictable In Equity Markets

Dimensional Fund Advisors, 2002 Essay

consistently outperformed large stocks over the entire history of the stock market from 1926 through the late 1970s. Later, research by Professors Eugene Fama and Kenneth French identified equity market exposure, capitalization, and price relative to fundamentals as the 3 factors that primarily determine the returns of a broadly diversified portfolio. Their work has held up through rigorous open review and Dimensional strategies focus on their insight. 3) Combination of Theory and Practice. By acting…

Words 1839 - Pages 8

Active Portfolio Essay

that this was a well diversified group of industries that reflected the UK economy well. We decided initially to weight them all equally (10% weighting per stock). After diversification our secondary criteria was choosing stocks that we believed had a high probability for abnormal growth. We also believed that it would be beneficial to use companies who had been listed on the London stock exchange for a long time as the more sample data available the stronger our results would be. The stocks chosen…

Words 4051 - Pages 17

Case Study Of Equity In Equity

is $180,001 and over (This is taxed at $54,547 plus 45c for each $1 over $180,000). He wishes to invest $100,000 dollars to start his equity investment experience whilst having the potential to grow his wealth for the future. As a young male with a high salary our client is extremely risk tolerant to this kind of investment. On a scale of one to ten with one being very risk adverse and ten being extremely risk tolerant our client would be a nine or ten. His main goal is to get a maximum possible return…

Words 4672 - Pages 19

Efficient Capital Markets A review of theory and empirical work Essay

American Finance Association Efficient Capital Markets: A Review of Theory and Empirical Work Author(s): Eugene F. Fama Source: The Journal of Finance, Vol. 25, No. 2, Papers and Proceedings of the Twenty-Eighth Annual Meeting of the American Finance Association New York, N.Y. December, 28-30, 1969 (May, 1970), pp. 383-417 Published by: Wiley for the American Finance Association Stable URL: http://www.jstor.org/stable/2325486 . Accessed: 02/08/2014 05:59 Your use of the JSTOR archive indicates your…

Words 13832 - Pages 56