Fama And French Model And Capm Finance Essay - Free Essay Example

Sample details Pages: 6 Words: 1708 Downloads: 7 Date added: 2017/06/26 Category Finance Essay Type Narrative essay Did you like this example? Estimating the expected return of the asset is the fundamental of finance subject and it is vital to the existence of the business. There are two models of asset pricing widely used to calculate the cost of equity: Capital asset pricing model (CAPM) and Fama and French three factor model. This report will critically analyze the strength as well as weakness between two models; also, it will explain the reason why CAPM are widely used by the manager even though it has quite a lot of shortcomings. Don’t waste time! Our writers will create an original "Fama And French Model And Capm Finance Essay" essay for you Create order CAPM (Capital asset pricing model) is used to calculate the expected return on one stock, indicating the close relationship between the expected return of the risky asset and the Beta (specific systematic risk, derived from the time-series regression analysis). CAPM predicts that stocks with high expected return should have high risk because the expected return has positive linear relation with the non-diversifiable risk i.e. Beta. (IRJ) CAPM equation: E(r) = rf + Beta[E(rm) rf] CAPM is widely used to estimate the discount rate of the firms future cash flows. Another application of CAPM is the Sharpe ratio e.g. reward to variability ratio, it measures the performance of the asset by dividing the expected return by the standard deviation. (investment) SML (Security market line) graphs the relationship between Beta and the expected return, it measures the rate of return needed to compensate for the risk born by the investors, and for the time value of money as well. As long as CAPM holds, all assets should lie on the SML. Securities lie above the SML will have greater expected return with the same risk, which means they are underpriced, the difference between the actual and expected return is called alpha or abnormal return. In reality, the investor would like to buy the underpriced and sell the overpriced securities. CML (Capital market line) shows the relationship between the expected return and the standard deviation by mixing risky portfolio with the risk free asset.(Bodie) The Sharpe-Lintner model indicates that the Jensens alpha or intercept is zero. Actually, according to recent tests of Douglas (1968), Black, Jensen and Scholes (1972), Blume and Friend (1973) as well as Fama and French (1992), the intercept is greater than the risk free rate. (JEP) According to Banz(1981), CAPM model fails to explain the relation between the firm size and the expected return, which is called size effect. Similarly, the book-to-market ratio is anot her important factor that can affect the return of the stock. Several tests have proved that Beta alone is not enough to explain all the risks in reality. (IRJ) CAPM works by estimating beta from the market, combining it with the risk free rate and market return to calculate the cost of equity capital. However, several empirical tests have proved that the actual relation between Beta and the expected return is much lower than the prediction of CAPM. According to Friend and Blume, CAPM indicates that high beta stocks have high returns and low betas stocks have low returns, which is imprecise. (JEP) To overcome this weakness, researchers such as Jensen and Scholes (1972), Friend and Blume (1970) have tested and they conclude that using Beta of a portfolio would be more precise than using Beta of individual stock. Beta can explain individual stock return therefore it is able to explain the portfolio return; using portfolio beta can help reduce errors in variable problems. Althoug h this method still has a small problem, it decreases the statistical power; it can be fixed by sorting portfolios by the beta, from the lowest to the highest. (JEP) To examine the efficiency of Beta, an empirical test on the Athens Stock Exchange (ASE) has been run: 100 stocks have been selected from FTSE/ ASE 20, FTSE/ ASE Mid 40 and FTSE/ ASE Small Cap and they were formed into 10 portfolios. The table below is the summary of the result from the regression analysis. Portfolio rp beta (p) a10 0.0001 0.5474 b10 0 0.7509 c10 -0.0007 0.9137 d10 -0.0004 0.9506 e10 -0.0008 0.93 f10 -0.0009 0.9142 g10 -0.0006 1.0602 h10 -0.0013 1.1066 i10 -0.0004 1.1293 j10 -0.0004 1.2024 Average Rf 0.0014  Average rm=(Rm-Rf) 0.0001 Source: Metastock (Greek) Data Base and calculations (S-PLUS) (IRJ) One of the main points of CAPM is that high Beta should result in high expected return. Nevertheless, the test on 100 stocks of ASE has provided an opposite conclusion. Portfolio a10 has the lowest Beta (0.5474) but it has the highest return (0.0001) while j10 has the highest Beta with the lowest return. FAMA Beside CAPM, the three factor model (or Fama and French model) is another alternative to achieve asset pricing. According to the model, the sensitivity of the expected return depends on those three factors: + The difference between the return on the market portfolio and the risk free rate: rm rf + The difference between the return on the portfolio of small stocks and the portfolio of large stocks: SMB (small minus big) + The difference between the return on the portfolio of high book- to- market- value stocks and portfolio of low book to market value stocks: HML (high minus low) The expected return of stock i is: Er(i) rf = alpha(i) + Beta(i) (rm rf) + Beta(SMB) r(SMB) + Beta(HML) r(HML) + e(i) Fama and French indicate that firms with high book to market value ratio and positive slope on HML are more likely to gain higher returns and in return, have higher possibility in facing financial distress because small firms are more sensitive to changes of the market. (Multifactor) One of the most serious defects of Fama and French model is the momentum effect of Jegadeesh and Titman (1993), which indicates that stocks which showed high returns in the past 3 or 12 months will continue to gain high returns in the next several months and similarly, stocks performed badly in the past would continue to have poor performance. This assumption is left unexplained. (JEP)(Multi) Also, bad-model is another problem that Fama as well as other asset pricing model fail to explain. Although the three factor model seems to give more accurate result, it is still based on the empirical model of expected returns; however that model cannot completely explain the average return. The bad-model effect is less serious in the short term returns (daily); however, it becomes important in long term returns, especially on small stocks. (10.1) Finally, because Fama and French explain more clearly the factors of risk, it requires detailed forecast of market index r eturn, SMB as well as HML return, which make it difficult and expensive to apply this method.(Bodie) Compare: Beta from CAPM alone cannot fully explained the total risk of the stock, while Fama and French model indicates that the sensitivity of the return depends on the market, size and book-to-market ratio to explain the expected return, many studies have proved that the Fama and French model provides a more accurate estimation for the expected return. CAPM fails because Beta shows little relation to variables such as BE/ME, PE and CP ratio which are important in determining the expected return. Here is an example of applying Fama and French model and CAPM in Thailand Stock Exchange: 421 companies are divided into 6 groups: SH, SM, SL, BH, BM, BL. S and B are the size of the company, whereas H, M, L represents the book-to-market value. SH BH SM BM SL BL 114 14 122 56 52 63 (Thailand) The table below shows the adjusted R squared of CAPM and Fama and French model in Thailand Stock Exchange from 2002 to 2007: According to Bodie, adjusted R-s quared is the square root of the correlation coefficient, it estimates the regression line. It is called the measure of goodness -of-fit; adjusted R-squared is also a tool to compare the usefulness among models because it can measure how much of the difference in individual stock return can be explained by the estimation. (Compare)  CAPM Fama and French SH 0.295 0.567 BH 0.077 0.91 SM 0.143 0.33 BM 0.231 0.885 SL 0.351 0.384 BL 0.671 0.669 According to the table above, the value of adjusted R-squared of Fama and French model dominates the CAPM. The average value of FF model is 0.63 where as CAPMs is 0.3. The range of CAPM is from 0.077 to 0.671 while FF models range is from 0.33 to 0.91. Apparently, Fama and French model can express more efficiently than CAPM model. (Thailand) Here is another test ran by Zhi Da (2008) to compare the efficiency between two models: A set of 30 portfolio has been created and analyzed:  Cross sectional Analysis  CAPM FF 3 Factor Average Factor Return Intercept 0.0034 0.005   -1.76 -2.41 [1.75] [2.39] MKT 0.0058 0.0038 0.0067  -2.22 -1.41  [1.85] [1.18] SMB  0.0041 0.0021  -1.98  [1.72] HML 0.0017 0.0042  -1.11  [0.88] adj R2 32.51% 35.91% (item) According to the table, the intercept of Fama and French model is consistent with its theory, it is greater than CAPMs (0.005 versus 0.0034), while FFs market factor is less than CAPMs. The significant strength of the three factor model is that it acounts for the risk of the size and book-to-market ratio of the company, and therefore the model has higher coefficient as opposed to CAPM, Fama and French model can explain nearly 36% of the expected return, whereas CAPM can explain only 32.5%. Conclusion: CAPM indicates that Beta alone can explain all the risks related to the expected return, the discount rate and Beta is strongly related. However, several tests have proved that CAPM failed. The first point is that the intercept is actually greater than the risk free rate. Secondly, Beta alone is not enough to explain the risk; the expected return can be affected by other factors such as the size and book-to-market ratio. And finally, in reality, Beta does not have the relationship with expected return as strong as predicted by CAPM. Fama and French model provide a more accurate estimation as opposed to CAPM. It indicates that the expected return are affected by three factors: market return, size effect (SMB) and book-to-market ratio (HML). However, it still has shortcomings. The first defect is that it failed to explain the momentum effect. Secondly, not only Fama and French but others asset pricing model are based on the empirical model of expected return, which cannot complete ly explain the average return. Finally, the three factor model is quite complex and expensive to apply. If the forecast of the market return, SMB or HML is not accurate, then the result might be worse than CAPMs. Thus, although CAPM model still has a lot of defects, it is still widely used by managers. (Bodie)

Morality and Gay Rights Discourse Essay - 2620 Words

Morality and Gay Rights Discourse When Aristotle discussed the material premises of enthymemes as being important in rhetoric, he was prescient of the kind of appeals that would be tendered by opponents in the discourse over gay rights issues long after his time. Smith and Windes express the nature of this conflict accurately when they write, â€Å"symbols expressing fundamental cultural values are invoked by all sides† (1997: 28). Similarly, Sarah S. Brown describes the participants in a â€Å"struggle to stake out symbolic positions of good and to frame their side in terms of morally powerful conceptions of right and wrong† (2000: 458). Fascinatingly, she suggests, â€Å"even people with deeply conflicting opinions appeal to the same moral†¦show more content†¦To begin with, however, we turn back to enthymemes. Terrence Cook (1980) identifies eight categories of standards that are referred to in the justification of political appeals – prudence, tradition, the supernatural, (human) nature, law, public opinion, prestige suggestion, and ideals. He writes, â€Å"Sometimes standards are implicit in myths or metaphors, symbolizations which are more than decoration when they tap through concretization of otherwise cold cognitions† (516). In fact, he may be referring to the power of fundamental, (almost) universally accepted principles that are woven into the constitutive ‘myths’ and stories of social realities. Only tacit allusion to these principles is required to trigger them within an audience and engage that audience in their own persuasion. Certainly, this is the phenomenon that Brown (2000) encounters when she notices how opposing factions of the debate surrounding same-sex parenting each make claim to the same value-laden concepts in their arguments. For example, both â€Å"pros† and â€Å"cons† reference the utmost importance of family, believe that human rights are indispensable, and share â€Å"a conception of prejudice as irrational and unjustified opposition to something, even using the same words to describe it: hateful, judgmental, ignorant† (449). The substance of their arguments, then, consists of each party attempting to load this â€Å"shared moral language† with definitional information that favors their opinion.Show MoreRelatedThe Ethics Of Foucault And Today1166 Words   |  5 PagesPhilosophy 28 June 2015 The Ethics of Foucault and Today Ethics has been studied from different spectrums throughout time whether political or moral based, a collective or individual effort, philosophers have studied theses values based on what is right and wrong. One thinker who is not commonly seen as a philosopher but referred to in countless works is Michel Foucault. 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Learning English Free Essays

English is the most widely spoken language in the world, and has more second-language speakers than any other language. English is also the language of the Internet, and so studying, doing research, interacting with international companies and travelling is almost impossible without at least some English. It is now impossible to find a country where learning English has not become popular. We will write a custom essay sample on Learning English or any similar topic only for you Order Now You wish to travel someplace, you have to communicate. If you don’t know the language of the country where you go, just try speaking English and they will understand. magine that you don’t know english and you go to china and of course you don’t know chinese and you need to find an address. how will you ask that address to some one ? and i can give you thousands of examples like that. Now in most of the job application the company ask about the languages you know. and all of them expect that you know english because international customers rely on English speaking employees to help them with day to day operations to interpret, translate and communicate directly with English speaking customers. Speak fluent English can improve job opportunities. There are other opportunities available for those who learn English. Learning English can improve the chances of being accepted into colleges. Learning English also can expand the ability to access news and information, much of which is generated only in English. if you are looking for an information on internet and if you are looking it in english you will find more than in your language. because english is an international language. you can find all the news , magazines, all the information you need you can find in english. as we all know music connects people to people. f you don’t know english how will you understand the meaning of the song and how will you enjoy it. music is really important in life. imagine a life without music how boring will it be. no music on the radio when you are in rush? i really can’t imagine a life like that . english is important for your education too. if you go to USA to study you get a better education than you will get in your country . you will meet some new international friends and some hay if you need some think from the countries that you have friends you will solve it easily. in the end learning english is the best thing to do for your life. How to cite Learning English, Essays

Half a Defence of Positive Accounting Research- A Critical Analysis

Question: Discuss about the Half a Defence of Positive Accounting Researchfor a Critical Analysis. Answer: Introduction The main argument discussed in the said paper highlights the optimistic approach towards accounting research. Accounting is a subject where the reasons with regards the behavioural pattern of human beings are explored along with complexity of the entities. The personal communication is replaced by impersonal communications where the information shared helps in taking sound decisions. To investigate the pros and cons of the accounting research, ontological and epistemological assumptions are explored. The paper describes the shortages with regards the manner in which the said research is performed which defeats the actual meaning of the same. The structure of the paper is such that it details about the positive researches that has taken place in accounting along with testing of certain hypothesis. Lastly it emphasises upon the fact that what is needed in to conduct a successful accounting research program. Summary of the Article The said article is written from a positivist view point where the concept of building and thorough testing of the same is a priority. It talks about the fact that the research project is crucial. It assumes certain assumptions while conducting research such as the fact that in the common parlance it is easy to procure reliable data about the happenings in the world. The intellectual program discussed about in this article is on economics and accounting which the author calls it positive research. It further discusses some examples which make it apparent that the research in accounting is very different from the Positive Accounting Theories spelt out by eminent economists. The first theory was developed by two American Professors Ross Watts and Jerold Zimmerman who stated that people look for opportunities for to multiply their income and financial position (Trang Thao, 2015). The main purpose of the positive accounting research is not to dig into exploration and experience but discover causation. While conducting the research it may seem that ontology and epistemology is not right but at the same time calling it to be meaningless and bizarre is also not correct. The concept of positive investigation is not very old in the field of accounting. Next it discusses about the various tests and methodologies that should be undertaken so as to convert the observations and summaries into theories. Along with the same there are discussions held wherein people try to falsify the stated theories as well and also state the methodologies adopted for proving such a falsification. The paper also highlights the fact that only quantitative research is not the basis simply because people often confuse the word quantitative with positive. A successful positive research cannot be conducted in isolation and neither by just stating theories. The theoretical models should be thoroughly tested so much that they would become unacceptable. More importantly the said article has made it clear that a wide gap exists between the actual scenario with regards performance of positive accounting research and what developments is actually needed so as to effectively contribute to the intellectual program. Research Question The main research question which is the centre point is the scientific research in economics and accounting. The author wants to plough into the concept of positive accounting research. A stream of intellectual enquiry hypothesis is assumed wherein The people belong to a world where the events and the various other activities are free from any kind of influences and wishes. These events are a part of the world due to certain reasons. In the common parlance it is very easy to obtain data about the various events if the same is observed minutely. The main reason behind such an observation is to gain an insight into the world specifically the causation. The article also talks about the fact that positive accounting research and just accounting research are two different concepts. However the above mentioned hypothesis is deeply researched by asking open questions. Firstly it questions the fact of existence of agency and the social environment attached to it. Then it emphasizes upon the ontological and epistemological hurdles which prevent the understanding of the accounting phenomena. The main issue being discussed is the agency problem Once these hypothesis are stated, the same has to be tested for any kind of falsification and for the same Poppers criterion is said to be one of the best suited. However any theory cannot be falsified by a single observation. Another very crucial research theory that is discussed is the fact that qualitative research is more fruitful than quantitative research (Gaffikin,2007). Ultimately it talks about the requirements for a successful positive research program along with revelation of a gap with regards the actual performance of the positive accounting research and the things needed to make it more powerful. Theoritical Framework Many theories have been stated in the said article with regards the positive accounting research. The theoretical framework doubts the hypothesis stated above. Firstly it states that everything in this world is interrelated i.e. the social environment is dependent upon the human beings and vice versa. The main issue lies with the aspect of agency simply because humans tend to behave as per their own wishes without any influences and due to this there is a problem of rationality. Ontology and epistemology to be positive always is not right but at the same time it would be incorrect to call it unreasonable. Scientific research in economics and accounting is more focussed upon collection of adequate information be it in value terms or quality. It considers the theory stated by Popper as one of the most suitable one in terms of scientific research. Popper has stated certain steps to be followed which is observation and development of initial ideas, development of formal theory where the qualitative predictions are given more weightage in comparison to quantitative predictions as it is more prone to falsification. The new theory is again tested for falsification and the steps are repeated again until a theory is arrived, in which the falsification is at its minimal (Mealing, 2010). The main reason behind the same is to formulate one such theory amongst many which is the most effective of all. The framework also emphasises upon the fact that more than two theories are tested against each other as testing of a single theory will not reap results as desired. The same is illustrated in the bel ow mentioned diagram. SOURCE: Shuttleworth, 2010 Further to this it also mentions the ways and means adopted for falsification of theories. A single surveillance cannot fabricate a theory, in fact a series of observations which are decisive in nature help to prove whether a theory is acceptable or not. With regards positive accounting research both quantity and quality of data collected matters. The framework also defines the main reason behind conducting positive research in accounting. Firstly one needs to collect the relevant information which would enable development of initial understanding of the theory. For conducting quantitative research, a detailed conversation with the auditors and the client is required to be done so as to explore the various factors behind determination of the audit fees. Second purpose for conducting a qualitative positive research is for testing of the theories. The quantitative forecasts can be done basically with regards the explanations based on economics only. However, affirmations are the most frequently used theoretical framework which makes it clear that the components of the world behave in certain particular manner. It is this assertion that confirms the scope of the scientific research program. Unfortunately the qualitative accounting research method does not answer the said question as to whether such a claim is true or not. Assuming that the accounting information is prone to noise and measurement inaccuracies, statistics have a vital impact in positive accounting research. Statistics is basically estimation of the data and the same is incorrectly used in conjunction with hypothesis testing. Thus it can be rightly said that the hypothesis testing gives a very feeble proof in support of a particular substitute proposition. The author has confirmed that the positive accounting research points at understanding the human nature and the reasons for them to behave in an absurd manner. Further it also states that the decisions taken by humans in a complex setting of an organization is prejudiced by the specialised data and various internal control systems which are in place. The author also reiterates the fact that in order to gain out of the Popperian approach to positive research accounting, more and more theoretical models are required which should be tested thoroughly against relevant data. Further to this if the various eminent researchers test their models against the data then it is sure to fail the test. Simple reason being that the realities differ from the formulated models. Thus these theoretical frameworks clearly show that the positive accounting research is yet to be fully developed. Significance and Limitations of the Article The significance of the said article is that it discusses about the positive accounting research from a broader perspective. It highlights the behavioural pattern of human beings in the various organizational settings. The researches ontology and epistemology is thoroughly tested. Further the author has not just stated theories but also explained the same with examples and diagrams which makes it very comprehensive for the readers to judge. It does not accept theories and models in total but believes in conducting tests trying to prove the said models inadequate. Secondly the author believes in quality of work and models rather than just quantity. He also denies the dependability on any one theory and conducts tests of theories against each other to ensure better comparability of results and thus enabling ease in making decisions. The said article although is very significant in various aspects yet it has certain limitations which deters it from calling it a perfect one. The article does not discuss about the minute situations and just looks for the broader perspective. While analysing any data with a larger denominator , the small and specific numbers and analysis gets ignored. Secondly the author is too optimistic in his approach and thus tends to ignore the negative aspects as well which have a major impact on the models and the accounting theories practiced presently (Denzin, Lincoln 2000). Further to this the examples used in many places is also irrelevant to the topic i.e comparing the accounting research with mythology and such other religious stories which have no relation with the said concept. Lastly the author lacks in thinking multi-dimensional and continues to emphasise on the auditing as a subject matter. Author should have chosen from a more prominent area of accounting instead of choosing audi ting which is ore related to post accounting work. However since the author does not acknowledge these limitations due to a more positive view point, the significance of the said research gets defeated. Conclusion Thus on a concluding note the said research paper identifies the fact that the present practice adopted for conducting positive accounting research does not fulfil the requirements so much that the present research program is not operated effectively. The theoretical models formulated are not as per the requirements and do not serve the main purpose behind such formulations. Analysing the said theory and research just on the basis of auditing practice narrows down the theories to a considerable level. The fundamentals regarding the qualitative research is to be explored deeper which would enables testing of various theories simultaneously rather than testing any one in isolation. The positive accounting research undoubtedly has a major contribution to make in analysing the behavioural patterns of human beings in lieu of the complexity in the accounting profession as well as the entity. The main aim behind the said research is to enable the researchers perform their task with ease. Thus I feel that the said article has given adequate data with regards the positive accounting research but failed to give real life and more related examples to explain the theory more clearly. References Denzin, N.K., Lincoln Y.S., (2000), Handbook of Qualitative Research, Available at https://libguides.usc.edu/writingguide/qualitative (Accessed 14th December 2016) Gaffikin, M., (2007), Accounting Research and Theory : The age of neo-empiricism, Australasian Accounting Business and Finance Journal, vol.1, no. 1 Mealing, P.P., (2010), Karl Poppers Criterion, Available at https://journeymanphilosopher.blogspot.in/2010/03/karl-poppers-criterion.html (Accessed 14th December 2016) Shuttleworth, M., (2010), Karl Poppers Basic Scientific Principle, Available at https://explorable.com/falsifiability (Accessed 14th December 2016) Trang, T.N., Thao, P.H., (2015), Positive Accounting An Effective Trend For Vietnamese Accounting In the New Era, Available at https://www.rusnauka.com/29_PMN_2015/Economics/7_198718.doc.htm (Accessed 14th December 2016)