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Level 67

Asset Pricing


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insurance premium
payment to get out of a risky situation
Tangent portfolio
risky portfolio on the efficient frontier whose tangent line cuts the vertical axis at the risk free rate
new efficient frontier
portfolio composed of the risk free rate and the tangent portfolio the tangent portfolio that offer the highest expected rate of return for any given level of risk.
short position
one who is selling is said to be in _______
separation theorem
theory that the investment decision, is separate from the financing decision (how much should be invested or borrowed in the risk free asset)
Capital Asset Pricing Model
The capital asset pricing model is a theoretical description of the way in which the market prices investment assets.
capital market line
line depicting the highest attainable expected return for any given risk level that includes only efficient portfolios
Market Price of Risk
Quantifes the extra return that investors demand to bear portfolio risk
Sharpe Ratio
Slope of the capital market line
beta
responsiveness of a stocks expected return to changes in teh value of the complete marekt portfolio of that stock
characteristic line
line of best fit through the returns on an individual asset, plotted on the vertical axis, relative to the returns for the market, plotted along the horizontal axis
Security Market Line
The positively sloped straight line displaying the relations between expected return and beta.
Market Risk Premium
The slope of the SML. The difference between the expected return on a market portfolio and the risk-free rate.
arbitrage pricing theory
pricing model that uses multiple factors to relate expected returns to risk by assuming that asset returns are linearly related to a set of indexes which are proxy risk factors that influence asset returns
arbitrage
when an investor simultaneously buys something at some price in one market and seek to sell it for a higher price in another market
no arbitrage principle
rule that two otherwise identical assets cannot sell at different prices
efficient market
when society's wellbeing is maximized
Efficient Market Hypothesis
The hypothesis that actual capital markets, such as the NYSE are efficient.
weak form efficient
characters of a market in which asset prices fully reflect all market data, which refers to all past price and volume trading information
abnormal profit
profit in excess of those expected for the assets level of risk
semi strong form efficient
characteristic of a market in which all publicly known and available information is reflected in security prices
Event Study
Examine abnormal returns before and after the release of new info that affects a firm's intrinsic value, such as earnings announcements or dividend changes. The null hypothesis is that investors should not be abl…
strong efficient
characteristic of a market in which stock prices fully reflect all information, which includes both public and private information
disclosure
revelation of all material facts so that everyone in the market is buying and selling based on the same material facts about the firm
Anomaly
Something that deviates from the common rule.
Active trading strategy
trading based on timing the market, trends or other criteria
Passive investment strategy
Does not seek superior risk-adjusted returns. (buying and holding a broad market portfolio)
cognitive bias
mistake in decisions making that results from one's own preferences and beliefs
prospect theory
the area of study of how individuals make choices given information about probabilities and outcomes
Loss Aversion
Refers to the tendency for investors to be more risk averse when faced with potential losses and less risk averse when faced with potential gains.
anchoring
tendency to use inappropriate or irrelevant factors in decision making