#CAPM MODEL WITH ALPHA PDF HOW TO#

#CAPM MODEL WITH ALPHA PDF HOW TO#

Given the CAPM doesn’t work that well in practice, perhaps we should look into how to use the Fama French model (which isn’t perfect or cutting edge, but a solid workhorse nonetheless). Regardless, being that this blog is dedicated to empirical data and evidence, and not about ‘mentally masturbating about theoretical finance models,’ we’ll operate under the assumption that the CAPM is dead until new data comes available. Roll’s critique–maybe the CAPM isn’t a junk theory, rather, the empirical tests showing the CAPM doesn’t work are bogus.Everyone learns about it and knows how to use it (although, Graham and Harvey suggest that many practitioners don’t even apply the CAPM theory correctly).Of course, there are lots of arguments to consider before throwing out the CAPM. It is also interesting that CFOs pay very little attentionto risk factors based on momentum and book-to-market-value.” ”…practitioners might not apply the CAPM or NPV rule correctly. Of course, even if it is applied properly, it is not clear that the CAPM is a very good model. “While the CAPM is popular, we show later that it is not clear that the model is applied properly in practice. Welch (2008) finds that ~75% of professors recommend the use of the model when estimating the cost of capital, and Graham and Harvey (2001) find that ~74% of CFOs use the CAPM in their work.Ī few quotes from Graham and Harvey 2001 sum up common sentiment regarding the CAPM: Given such a poor track record, is anyone still using the CAPM? If you’d like to see how I calculated the charts above, please reference the excel file.

Moreover, closer inspection indicates that the small-value and the small-growth portfolios are really out of wack. Additional information regarding the construction of these results is available upon request.Īgain, the CAPM doesn’t do a good job of explaining returns. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Therefore, these findings challenge the common practices of using monthly (quarterly/annually) and short-horizon data among the practitioners and researchers in asset pricing work.The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. 2) Medium-horizon data is more reliable and efficient, has more explanatory power, and fits better with the assumption of market efficiency compared with monthly data. These findings show 1) daily data is more reliable and efficient, has higher forecasting power, and fits better with the assumption of market efficiency compared with monthly data. The CAPM using medium-horizon data yielded a statistically significant higher model fit, smaller Beta standard deviation and Alpha, and much less zeroed Betas compared with short-horizon data. Using a Gibbs sample, the Bayesian framework via both parametric and non-parametric Bayes estimators, confidence interval approach, and six data sets (two daily, two weekly, and two monthly data) from a sample of 150 randomly selected S&P 500 stocks from 2007 – 2019, the empirical results showed that the CAPM using daily data yielded a statistically significant higher model fit and smaller Beta standard deviation, model error, and Alpha compared with monthly data. This research argued for estimating the Capital Asset Pricing Model (CAPM) using daily and medium-horizon data over monthly and short horizon-data.

Capm model with alpha pdf