International Journal of Economics and Financial Issues Vol. 2, No. 2, 2012, pp.141-178 ISSN: 2146-4138 www.econjournals.com

Theoretical and Empirical Review of Asset Pricing Models: A Structural Synthesis Şaban Çelik Deparment of International Trade and Finance, Yasar University, Izmir, Turkey. Tel: +90-232-4115343; Fax: +90-232-4115020. E-mail: saban.celik@yasar.edu.tr

ABSTRACT: The purpose of this paper is to give a comprehensive theoretical review devoted to asset pricing models by emphasizing static and dynamic versions in the line with their empirical investigations. A considerable amount of financial economics literature devoted to the concept of asset pricing and their implications. The main task of asset pricing model can be seen as the way to evaluate the present value of the pay offs or cash flows discounted for risk and time lags. The difficulty coming from discounting process is that the relevant factors that affect the pay offs vary through the time whereas the theoretical framework is still useful to incorporate the changing factors into an asset pricing models. This paper fills the gap in literature by giving a comprehensive review of the models and evaluating the historical stream of empirical investigations in the form of structural empirical review. Keywords: Financial economics; Asset pricing; Static CAPM; Dynamic CAPM; Structural empirical review JEL Classifications: G00; G12; G13

1. Introduction In order to simplify the concept of asset pricing, it needs to give a snapshot of the literature and a brief overview of perspectives in the field in addition with to describe what it is meant by an asset. The assets, financial or nonfinancial, will be defined as generating risky future pay offs distributed over time. Pricing of an asset can be seen as the present value of the pay offs or cash flows discounted for risk and time lags. However, the difficulties coming from discounting process is to determine the relevant factors that affect...

...Running head: PRICINGMODELSPricingModels
Adam F. Thornton
FIN 501 – 3
TUI University
Dr. William Anderson
Chipotle Mexican Grill (CMG) is one of the fastest growing restaurant chains in the United States. Self proclaimed as “fast-casual,” CMG offers a dining experience that is unique, organic, and which draws from the local economy. For the investor, CMG is a wise investment for the aggressive and fast growing portion of a portfolio. When determining an appropriate model to evaluate CMG’s potential, the Capital AssetPricingModel (CAPM) is the best choice. This model offers the best amount detail while maintaining the simplicity needed for a model outlining investment decisions in CMG.
The PricingModels
There are three pricingmodels to discuss when evaluating CMG: dividend growth, CAPM, and the Arbitrage Pricing Theory (APT). Each of these models has both advantages and disadvantages, easily tailoring one model to different situations. However, the CAPM is best suited for this case with CMG. Below is a further review on each of models’ advantages and disadvantages, and applicability to CMG’s market position and financial situation.
The Gordon...

...CAPITAL ASSETPRICINGMODEL
The CAPM says that the expected return of a security or a portfolio equals the rate on a risk-free security plus a risk [pic]premium. If this expected return does not meet or beat the required return, then the investment should not be undertaken. The security market line plots the results of the CAPM for all different risks (betas).
Using the CAPM model and the following assumptions, we can compute the expected return of a stock in this CAPM example: if the risk-free rate is 3%, the beta (risk measure) of the stock is 2 and the expected market return over the period is 10%, the stock is expected to return 17% (3%+2(10%-3%)).
THE CAPM MODEL
A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities.
[pic]
The general idea behind CAPM is that investors need to be compensated in two ways: time value of money and risk. The time value of money is represented by the risk-free (rf) rate in the [pic]formula and compensates the investors for placing money in any investment over a period of time. The other half of the formula represents risk and calculates the amount of compensation the investor needs for taking on additional risk. This is calculated by taking a risk measure (beta) that compares the returns of the asset to the market over a period of time and to...

...Chapter 9: Multifactor Models of Risk and Return. (QUESTIONS)
1. Both the capital assetpricingmodel and the arbitrage pricing theory rely on the proposition that a no-risk, no-wealth investment should earn, on average, no return. Explain why this should be the case, being sure to describe briefly the similarities and differences between CAPM and APT. Also, using either of these theories, explain how superior investment performance can be establish.
Answer:
Both the Capital AssetPricingModel and the Arbitrage PricingModel rest on the assumption that investors are reward with non-zero return for undertaking two activities:
(1) committing capital (non-zero investment); and (2) taking risk. If an investor could earn a positive return for no investment and no risk, then it should be possible for all investors to do the same. This would eliminate the source of the “something for nothing” return.
In either model, superior performance relative to a benchmark would be found by positive excess returns as measured by a statistically significant positive constant term, or alpha. This would be the return not explained by the variables in the model.
2. You are the lead manager of a large mutual fund. You have become aware that several equity analysts who have recently joined your management team are...

...
How far the Capital AssetPricingModel has been successful in explaining asset returns, defining its approach and assumptions.
Semester 2013
Department of Accounting and Finance
Lord Ashcroft International Business School
Anglia Ruskin University
Table of Contents
Introduction…………………………………………………………………………......... 3
What’s Capital AssetPricingModel…………………………………………………..... 3 1. Definition………………………………………………………………………………...3 2. Terminology……………………………………………………………………………...3
Risk and Capital AssetPricingModel………………………………………………….. 3 1. Systematic Risk…………………………………………………………………………..3 2. Unsystematic Risk………………………………………………………………………..3
Asset Returns and Capital AssetPricingModel……………………………………….. 3
Capital AssetPricingModel Explanation…………………………………………….... 4 1. Formula…………………………………………………………………………………..4...

...Table of Contents
Introduction 5
1.1 Research Background .6
1.2 Research Aim 6
1.3 Research Objective 7
1.4 Research Questions 8
Literature Review 9
2.1 Prior Evidence of the Four-Factor Model in the UK 13
2.2 Hypotheses 15
Data and Methodology 17
3.1 Research Data 17
3.2 Research Methodology 18
Empirical Results and Discussion 21
4.1 Summary Statistics 21
4.2 Data Analysis 27
4.2.1 Full Sample Regression 27
4.2.1.1 Full Sample Analysis 28
4.2.1.2 Graph of the Full Sample Analysis 30
4.2.2 Bull Market Regression 34
4.2.2.1 Bull Market Analysis 35
4.2.3 Bear Market Regression 38
4.2.3.1 Bear Market Analysis 39
4.2.4 Behavior Finance Arguments 40
Summary and Conclusion 42
5.1 Recommendations 43
References 44
Appendices 49
Table 1 : Summary Statistics 21
Table 2(a): Excess Returns on the six portfolios (Full Sample) 24
Table 2(b): Excess Returns on the six portfolios (Bear Market) 25
Table 2(c): Excess Returns on the six portfolios (Bull Market) 26
Table 3 : Regression on the six portfolios (Full Sample) 27
Table 4 : Regression on the six portfolios (Bull Market) 34
Table 5 : Regression on the six portfolios (Bear Market) 38
Figure 1 : Market Factor 30
Figure 2 : Size Factor 31
Figure 3 : Book-to-market Factor...

...Capital AssetPricingModel (CAPM): Pros and Cons.
CAPM defines the relationship between risk and return. The premise of the model is that the expected investment return varies in direct proportion to its risk, i.e., the riskier the investment - the higher the return you should expect.
Shows:
• how much risk you are taking when investing in an instrument?
• whether the instrument is rightly priced
• whether you are getting sufficient return for the risk you are taking
CAPM calculates the risk-adjusted discount rate with the risk-free rate, the market risk premium, and beta (mathematical formula):
Return (R) = Rf + beta x (Rm - Rf)
Rf is the rate of risk-free investments
Beta - the risk of loss associated with your investments.
Rm is the expected market return.
(Rm-Rf) – market risk premium
beta x (Rm - Rf) – risk premium of specific company
Investments are good if the expected return from the investment equals/exceeds required return.
Market Risk Premium [Rm-Rf]
The additional return over the risk-free rate needed to compensate investors for assuming an average amount of risk
Its size depends on the perceived risk of the overall stock market and investors’ degree of risk aversion
Varies across time. Usually ranged between 4-8%
BETA in CAPM measures a stock’s degree of systematic or market risk. It can also be thought of as the stock’s contribution to the risk of a well-diversified...

...CAPITAL ASSETPRICINGMODEL
The Capital AssetPricingModel deals with independent investor problems that needs to undergo the procedure of selection of securities involving risks. The investors need to select the most advantageous security that produces the best possible outcome. This model deals with the estimation of securities as well as it links the risk and return (the expected shares). There is a direct relationship and risk and return provides higher expected return from that security. CAPM is considered the key model for helping in decision making regarding the selection of securities and also helps in planning the strategies.
Types Of Risks – The unsystematic or the diversifiable risk is related to the haphazard causes which can be eradicated or removed with the help of diversification. Similarly the systematic or the non-diversifiable risk is related to the factors of the market which cannot be removed with the help of diversification. The permutation of both the risks is the total risk. The investors choose the systematic risk over the unsystematic as it helps the investors in the selection of the assets.
The derivation of the Capital AssetPricingModel has taken place with the assumption of indirect symmetry in the returns from the assets. This basically shows that the...

...A Chartered Financial Analyst, Jeffrey Bruner, uses the Capital AssetPricingModel (CAPM) to help identify mispriced securities. However, a consultant suggests Bruner to use Arbitrage Pricing Theory (APT) instead. As the following, it will mention the role of CAPM in the modern portfolio management; to clarify the APT faction and explain the reasons why should Bruner use APT to help identify mispriced securities.
In modern portfolio management, the role of Capital AssetPricingModel (CAPM) is a model that attempts to describe the relationship between the risk and the expected return on an investment and that is used in the pricing of risky securities. The assumption behind the CAPM is that there is only one risk-free rate in the model, investors can borrow and lend unlimited amounts under the risk rate of interest; the perfect information is freely available to all investors who, as a result, have the same expectations; that all investors are risk averse, rational and desire to maximise their own utility; and the capital market is characterised by perfect competition, there are broadly diversified across a range of investments and the investors will only require a return for the systematic risk of their portfolio, since unsystematic risk has been removed and can ignored. It also assumes all investors choose their portfolio...