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Econ 487
Outline
Conditional CAPM
CAPM Readings
human capital
Counter-Attack
Conditional CAPM?
Excess-Return Market Model
!
R
it
" r
f
=#
i
$
+ %
i,M
(R
Mt
" r
f
) +&
it
,
where
!
"
i
#
="
i
$(1$%
i,M
)r
f
.
Take expectations of both sides and take
!
r
f
to right-hand-side:
!
E[R
it
] = r
f
+"
i
#
+ $
i,M
(E[R
Mt
] % r
f
)
The SML for CAPM implies
!
"
i
#
= 0 or, equivalently,
!
"
i
= (1#$
i,M
)r
f
.
Conditional CAPM
!
E
t
[R
it +1
] = r
ft
+ "
it
(E
t
[R
Mt +1
] # r
ft
)
where
!
"
it
=
cov
t
(R
it +1
, R
Mt +1
)
var
t
(R
Mt +1
)
In practice
!
var
t
(R
Mt +1
) changes a lot over time.
Unconditional Expectations
!
E[R
it +1
] = r
ft
+ "
i
(E[R
Mt +1
] # r
ft
) + cov("
it
, E
t
[R
Mt +1
])
I.e.,
!
"
i
#
= cov($
it
, E
t
[R
Mt +1
]) if conditional CAPM holds
Excess-Return Market Model
!
R
it
" r
f
=#
i
$
+ %
i,M
(R
Mt
" r
f
) +&
it
,
where
!
"
i
#
="
i
$(1$%
i,M
)r
f
.
Take expectations of both sides and take
!
r
f
to right-hand-side:
!
E[R
it
] = r
f
+"
i
#
+ $
i,M
(E[R
Mt
] % r
f
)
The SML for CAPM implies
!
"
i
#
= 0 or, equivalently,
!
"
i
= (1#$
i,M
)r
f
.
Conditional CAPM
!
E
t
[R
it +1
] = r
ft
+ "
it
(E
t
[R
Mt +1
] # r
ft
)
where
!
"
it
=
cov
t
(R
it +1
, R
Mt +1
)
var
t
(R
Mt +1
)
In practice
!
var
t
(R
Mt +1
) changes a lot over time.
Unconditional Expectations
!
E[R
it +1
] = r
ft
+ "
i
(E[R
Mt +1
] # r
ft
) + cov("
it
, E
t
[R
Mt +1
])
I.e.,
!
"
i
#
= cov($
it
, E
t
[R
Mt +1
]) if conditional CAPM holds
Conditional CAPM