Revisiting The Capital Asset Pricing Model.docx

1、Revisiting The Capital Asset Pricing ModelRevisiting The Capital Asset Pricing Modelby Jonathan BurtonReprinted with permission from Dow Jones Asset ManagerMay/June 1998, pp. 20-28For pictures and captions, click hereModern Portfolio Theory was not yet adolescent in 1960 when William F. Sharpe, a 26

2、-year-old researcher at the RAND Corporation, a think tank in Los Angeles, introduced himself to a fellow economist named Harry Markowitz. Neither of them knew it then, but that casual knock on Markowitzs office door would forever change how investors valued securities.Sharpe, then a Ph.D. candidate

3、 at the University of California, Los Angeles, needed a doctoral dissertation topic. He had read Portfolio Selection, Markowitzs seminal work on risk and returnfirst published in 1952 and updated in 1959that presented a so-called efficient frontier of optimal investment. While advocating a diversifi

4、ed portfolio to reduce risk, Markowitz stopped short of developing a practical means to assess how various holdings operate together, or correlate, though the question had occurred to him.Sharpe accepted Markowitzs suggestion that he investigate Portfolio Theory as a thesis project. By connecting a

5、portfolio to a single risk factor, he greatly simplified Markowitzs work. Sharpe has committed himself ever since to making finance more accessible to both professionals and individuals.From this research, Sharpe independently developed a heretical notion of investment risk and reward, a sophisticat

6、ed reasoning that has become known as the Capital Asset Pricing Model, or the CAPM. The CAPM rattled investment professionals in the 1960s, and its commanding importance still reverberates today. In 1990, Sharpes role in developing the CAPM was recognized by the Nobel Prize committee. Sharpe shared

7、the Nobel Memorial Prize in Economic Sciences that year with Markowitz and Merton Miller, the University of Chicago economist.Every investment carries two distinct risks, the CAPM explains. One is the risk of being in the market, which Sharpe called systematic risk. This risk, later dubbed beta, can

8、not be diversified away. The otherunsystematic riskis specific to a companys fortunes. Since this uncertainty can be mitigated through appropriate diversification, Sharpe figured that a portfolios expected return hinges solely on its betaits relationship to the overall market. The CAPM helps measure

9、 portfolio risk and the return an investor can expect for taking that risk.More than three decades have passed since the CAPMs introduction, and Sharpe has not stood still. A professor of finance at the Stanford University Graduate School of Business since 1970, he has crafted several financial tool

10、s that portfolio managers and individuals use routinely to better comprehend investment risk, including returns-based style analysis, which assists investors in determining whether a portfolio manager is sticking to his stated investment objective. The Sharpe ratio evaluates the level of risk a fund

11、 accepts vs. the return it delivers.Sharpes latest project is characteristically ambitious, combining his desire to educate a mass audience about risk with his longtime love of computers. Technology is democratizing finance, and Sharpe is helping to push this powerful revolution forward. Through Fin

12、ancial Engines, Sharpe and his partners will bring professional investment advice and analysis to individuals over the Internet.What do you think of the talk that beta is dead?The CAPM is not dead. Anyone who believes markets are so screwy that expected returns are not related to the risk of having

13、a bad time, which is what beta represents, must have a very harsh view of reality.Is beta dead? is really focused on whether or not individual stocks have higher expected returns if they have higher betas relative to the market. It would be irresponsible to assume that is not true. That doesnt mean

14、we can confirm the data. We dont see expected returns; we see realized returns. We dont see ex-ante measures of beta; we see realized beta. What makes investments interesting and exciting is that you have lots of noise in the data. So its hard to definitively answer these questions.Would you approac

15、h a study of market risk differently today than you did back in the early 1960s?Its funny how people tend to misunderstand the CAPMs academic, theoretical and scientific process. The CAPM was a very simple, very strong set of assumptions that got a nice, clean, pretty result. And then almost immedia

16、tely, we all said, lets bring more complexity into it to try to get closer to the real world. People went onmyself and othersto what I call extended capital asset pricing models, in which expected return is a function of beta, taxes, liquidity, dividend yield, and other things people might care abou

17、t.Did the CAPM evolve? Of course. Are the results more complicated shall just expected return is a linear function of beta relative to the Standard & Poors 500-Stock Index? Of course. But the fundamental idea remains that theres no reason to expect reward just for bearing risk. Otherwise, youd make

18、a lot of money in Las Vegas. If theres reward for risk, its got to be special. Theres got to be some economics behind it or else the world is a very crazy place. I dont think differently about those basic ideas at all.What about Harry Markowitzs contribution to all of this?Markowitz came along, and

19、there was light. Markowitz said a portfolio has expected return and risk. Expected return is related to the expected return of the securities, but risk is more complicated. Risk is related to the risks of the individual components as well as the correlations.That makes risk a complicated feature, an

20、d one that human beings have trouble processing. You can put estimates of risk/return correlation into a computer and find efficient portfolios. In this way, you can get more return for a given risk and less risk for a given return, and thats efficiency a la Markowitz.What stands out in your mind wh

21、en you think about Markowitzs contribution?I liked the parsimony, the beauty, of it. I was and am a computer nut. I loved the mathematics. It was simple but elegant. It had all of the aesthetic qualities that a model builder likes. Investment texts in the pre- Markowitz era were simplistic: Dont put

22、 all your eggs in one basket, or put them in a basket and watch it closely. There was little quantification.To this day, people recommend a compartmentalized approach. You have one pot for your college fund, another for your retirement fund, another for your unemployment fund. Peoples tendencies whe

23、n they deal with these issues often lead to suboptimal solutions because they dont take covariance into account. Correlation is important. You want to think about how things move together.Tell us about your relationship with Markowitz.Harry was my unofficial dissertation advisor. In 1960, he and I w

24、ere both at the RAND Corporation. My official advisor at the University of California at Los Angeles suggested I work with Harry, but Harry wasnt on the UCLA faculty. I introduced myself to him and said I was a great fan of his work.With Markowitzs encouragement, you delved into market correlation,

25、streamlining Portfolio Theory with the use of a single-factor model. This became part of your dissertation, published in 1963 as A Simplified Model of Portfolio Analysis.I did my dissertation under a strongly simplified assumption that only one factor caused correlation. The result I got was in that

26、 setting, prices would adjust until expected returns were higher for securities that had higher betas, where beta was the coefficient with the factor.Portfolio Theory focused on the actions of a single investor with an optimal portfolio. You wondered what would happen to risk and return if everyone

27、followed Markowitz and built efficient portfolios.I said what if everyone was optimizing? Theyve all got their copies of Markowitz and theyre doing what he says. Then some people decide they want to hold more IBM, but there arent enough shares to satisfy demand. So they put price pressure on IBM and

28、 up it goes, at which point they have to change their estimates of risk and return, because now theyre paying more for the stock. That process of upward and downward pressure on prices continues until prices reach an equilibrium and everyone collectively wants to hold whats available. At that point,

29、 what can you say about the relationship between risk and return? The answer is that expected return is proportionate to beta relative to the market portfolio.In a paper I finished in 1962 that was published in 1964, I found you didnt have to assume only one factor. That basic result comes through i

30、n a much more general setting. There could be five factors, or 20 factors, or as many factors as there are securities. In a Markowitz framework, where people care about the expected return of their portfolios and the risk as measured by standard deviation the results held. That paper was called Capi

31、tal Asset Prices: A Theory of Market Equilibrium Under Conditions Of Risk. Eugene Fama called it the Capital Asset Pricing Model. Thats where the name came from.The CAPM was and is a theory of equilibrium. Why should anyone expect to earn more by investing in one security as opposed to another? You

32、need to be compensated for doing badly when times are bad. The security that is going to do badly just when you need money when times are bad is a security you have to hate, and there had better be some redeeming virtue or else who will hold it? That redeeming virtue has to be that in normal times you expect to do better. The key insight of the Capital Asset Pricing Model is that higher expected returns go with the greater risk of doing badly in bad times. Beta is a measure of that. Securities or asset classes with high betas tend to do worse in bad