Hey guys, I am thinking about writing an honors thesis about valuation. Specifically, the assumptions and flaws of the CAPM model. I would also like to suggest other ways of thinking about risk, a la Graham, Price, and Klarman, as well as suggest a more forward looking rate to draw conclusions about CoC. Lastly, I would like to compare it to other models. However, the only other ones I’ve heard of are Fama-French’s 3 Factor Model (extension of CAPM) and Arbitrage Pricing Models. Anyone interested in helping me become aware of other interesting models?
Fama-French is a version of the Arbitrage Pricing Model, not actually separate from it. In fact, APT isn’t really a “model” in the way you usually think of it. It is technically a theory that says that if there are one or more paid risk factors, arbitrage will tend to make them linear. However, APT doesn’t actually tell you anything about what those factors should be. If you are writing about pricing models, it might make sense to do some kind of comparison of common APT factor models and compare them to how CAPM and F-F work. Try to come up with explanations (or a list of other people’s explanations, with a conclusion about what you think is the most logical/likely one) about why certain factors seem to be paid or not. By the way, CAPM seems to work decently. It’s not perfect by any stretch of the imagination, but even with all the other factor models for expected returns, it would be hard to identify any other single factor that seems to explain as much of a stock’s variance as the single factor of correlation to the market portfolio. It’s fun to laugh at CAPM, but it seems to do a pretty good job for a 1-factor model, and adding more factors doesn’t really increase the R^2 by all that much.
Thanks for the clarification. My goal would be to see if a model based on YTM of bonds is a more accurate measure of risk. My hope is that because YTM is forward looking while Beta is historical, I would be able to better predict required Cost of Equity.
ICAPM, CCAPM, Black-Litterman etc. etc. etc. Just do a search you will find so many your head will explode when you try to figure out what risks each one is pricing and how.
bchadwick Wrote: ------------------------------------------------------- > By the way, CAPM seems to work decently. It’s not > perfect by any stretch of the imagination, but > even with all the other factor models for expected > returns, it would be hard to identify any other > single factor that seems to explain as much of a > stock’s variance as the single factor of > correlation to the market portfolio. It’s fun to > laugh at CAPM, but it seems to do a pretty good > job for a 1-factor model, and adding more factors > doesn’t really increase the R^2 by all that much. The number I have seen show CAPM R^2 at about 70% and F-F R^2 at around 90% for diversified portfolios. I would love to see other research though. Can you point me to any? Edit: KB - not trying to jack your thread…I figured you would be interested in this information also.
Karateboy, James Montier recently released a book that may be helpful to your thesis. The contents are a compilation of his periodic strategy newsletters he authored while at SG and DB. Specifically, he takes the Klarman, Graham/Dodd (etc.) view of risk one step further by providing data and corresponding analyses. I’d definitely recommend it whether or not you pursue your current topic.
ValueAddict, Thank you. The books seems to go exactly in the direction that I am interesting in learning more about. Any thought on my initial thought of using YTM?