Lecture 1 Asset Pricing Models and Fund Performance
Lecture 1 Asset Pricing Models and Fund Performance
Var(R) = σ2
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Which Portfolio? MV frontier: Market Portfolio
Mean-Variance Framework
Efficient
Frontier
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How the return of a stock is decided? CAPM
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CAPM Lessons
3. Assets losing more in bad times (with high beta) require high risk
premiums
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Tests of Asset Pricing Models and Pricing Anomalies
Step 2:
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Portfolio Sorting
Fama and French (1992): sort by Size and Book-to-Market ratio every year.
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Risk and Return
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Mean/Stdev (%)
20 Mean
Stdev
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10
0
Market Small 1 Large 10 Growth 1 Value 10 Losers 1 Winners 10
Exposure to factor risk over the long run yields a risk premium
The premium does not come for free: it is compensation for bearing losses during
bad times. Being exposed to the factor results in holding risk that other investors
seek to avoid.
Pricing Factors
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Other Anomalies (will be introduced in Lecture 2)
Low-Vol Anomalies
Liquidity Risk
Seasonality
Hou, Xue and Zhang (2019) summarize 452 anomalies in the literature
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How to deal with new anomalies?
1. Industry: trade on it, and hope it will last
13 Eugene Fama
Mutual Fund Performance Puzzle
Mutual Fund Industry
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Mutual Fund Performance Puzzle
If you think everyone else is stupid, you're probably the stupid one. 17
Efficient Market Hypothesis --- Eugene Fama (1960s)
– states that markets are efficient, with market prices reflecting all
available information at any given time
1. Weak form – states that stock prices fully reflect all information
contained in past prices and volumes of trading
3. Strong form – implies share prices reflect all information, public and
private, and no one can earn excess returns
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Joint Hypothesis Problem
When real returns differ from expected returns (implied by the model)
Either
or
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Tests of Asset Pricing Models and Pricing Anomalies
Step 2:
Nobel Prize 2013 awarded to Eugene Fama, Lars Hansen, and Robert Shiller
Inefficient!
Efficient!
Efficient Markets?
2. Logically impossible that both market for asset management and asset markets fully
efficient
– Asset market efficient no one should pay for active management
Completely
Perfectly
Inefficient Efficient
EFFICIENCY-O-METER
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Efficiently Inefficient Markets
Markets must be
– inefficient enough that active investors are compensated for their costs
– efficient enough to discourage additional active investing
Investment implications
– some people must be able to beat the market
advantage 25
Flow-Performance Sensitivity Puzzle
Flow-Performance Sensitivity Puzzle
Fact 1: Investors chase best performing funds (Chevalier and Ellison 1997)
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Flow-Performance Sensitivity Puzzle
Fact 2: Best performing funds do not continue to outperform (Carhart 1997)
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Flow-Performance Sensitivity Puzzle
Facts:
If you think everyone else is insane, you're probably the one that is insane.
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Decreasing Returns to Scale
Manager A
AUM
(Asset Under Management) $ 1,000,000 $ 1,000,000,000
Abnormal Returns 10% ?
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Decreasing Returns to Scale
Manager A
AUM
(Asset Under Management) $ 1,000,000 $ 1,000,000,000
Abnormal Returns 10% 1%
Potentially because of
(1) the price impact of large trades
(2) limited number of investment ideas
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Berk and Green (2004)
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The economic rents (revenue) go to the managers who create them, not to the
investors who invest in them.
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Value Added Measure
Manager A Manager B
AUM
(Asset Under Management) $ 1,000,000 $ 1,000,000,000
Abnormal Returns 10% 2%
Abnormal Return / Revenue
(in Dollar) $ 100,000 $ 20,000,000
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Value Added Measure in Berk and van Binsbergen (2015 & 2017)
= f q (revenue in $)
Gross alpha is
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Size, value added, and gross alpha
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-- from Berk and van Binsbergen (2017)
Size, value added, and gross alpha
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-- from Berk and van Binsbergen (2017)
Why Gross and Net Alphas do not measure skill?
Manager A Manager B
AUM
(Asset Under Management) $ 1,000,000 $ 1,000,000,000
Gross Alphas 10% 2%
Fees 10% 2%
Net Alphas 0% 0%
Abnormal Return / Revenue
(in Dollar) $ 100,000 $ 20,000,000
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Summary: Why Gross and Net Alphas do not measure skill?
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Gross alpha always equals to the fee that funds charge (in equilibrium)
= f
When q > q*=a/2b, fund manager should index the excess money
= f ≠
Sorted by: past compensation (fees*AUM) past value added (gross alpha*AUM)
-- from Berk and van Binsbergen (2015)
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Using Vanguard Index Funds as the Benchmark
million $s / month
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