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Lecture

Factor Models and Pricing Theory

In course

FIN-609: Asset Pricing (2011 - 2024)

This course provides an overview of the theory of asset pricing and portfolio choice theory following historical developments in the field and putting emphasis on theoretical models that help our understanding of financial decision making and financial mar ...

Description

This lecture covers the concept of factor models and pricing theory, discussing the existence of a one-factor beta pricing model and the Capital Asset Pricing Model (CAPM). It explores the conditions for the market portfolio to be efficient and the relationship between factors and pricing errors in large diversified portfolios.

Instructor

Semyon Malamud

Official source

Ontological neighbourhood

Economics

Microeconomics: Financial economics

Related concepts (32)

Arbitrage pricing theory

In finance, arbitrage pricing theory (APT) is a multi-factor model for asset pricing which relates various macro-economic (systematic) risk variables to the pricing of financial assets. Proposed by economist Stephen Ross in 1976, it is widely believed to be an improved alternative to its predecessor, the Capital Asset Pricing Model (CAPM). APT is founded upon the law of one price, which suggests that within an equilibrium market, rational investors will implement arbitrage such that the equilibrium price is eventually realised.

Capital asset pricing model

In finance, the capital asset pricing model (CAPM) is a model used to determine a theoretically appropriate required rate of return of an asset, to make decisions about adding assets to a well-diversified portfolio. The model takes into account the asset's sensitivity to non-diversifiable risk (also known as systematic risk or market risk), often represented by the quantity beta (β) in the financial industry, as well as the expected return of the market and the expected return of a theoretical risk-free asset.

Modern portfolio theory

Modern portfolio theory (MPT), or mean-variance analysis, is a mathematical framework for assembling a portfolio of assets such that the expected return is maximized for a given level of risk. It is a formalization and extension of diversification in investing, the idea that owning different kinds of financial assets is less risky than owning only one type. Its key insight is that an asset's risk and return should not be assessed by itself, but by how it contributes to a portfolio's overall risk and return.

Asset pricing

In financial economics, asset pricing refers to a formal treatment and development of two main pricing principles, outlined below, together with the resultant models. There have been many models developed for different situations, but correspondingly, these stem from either general equilibrium asset pricing or rational asset pricing, the latter corresponding to risk neutral pricing.

Portfolio (finance)

In finance, a portfolio is a collection of investments. The term “portfolio” refers to any combination of financial assets such as stocks, bonds and cash. Portfolios may be held by individual investors or managed by financial professionals, hedge funds, banks and other financial institutions. It is a generally accepted principle that a portfolio is designed according to the investor's risk tolerance, time frame and investment objectives. The monetary value of each asset may influence the risk/reward ratio of the portfolio.

Related lectures (42)

Asset Pricing Theory: Mean Variance Analysis

Explores mean variance analysis, CAPM, risk aversion, and Sharpe ratio in asset pricing.

Factor Models and CAPM

Covers the Capital Asset Pricing Model, estimating betas, empirical evidence on returns versus beta, short-sale constraints, and optimal portfolio choice.

Investments: Portfolio Selection and Asset Pricing

Covers portfolio selection, asset pricing, market efficiency, and risk management in investments.

Capital Asset Pricing Model

Delves into the Capital Asset Pricing Model, market portfolio, Security Market Line, betas estimation, and liquidity risk.

Asset Pricing: Theory and Applications