Course Outline
Basics
- Return measurement
- Gordon growth model
- Cashflow v.s. discount rate variation
- Stock return predictability
Asset Pricing
- Stochastic discount factor
- Risk-neutral probabilities
- Arbitrage
- Law of one price
- Consumption-based asset pricing
- Equity premium puzzle
Asset Allocation
- Mean-variance preferences
- Tactical asset allocation
- Stock return predictability
- Market timing
- Volatility timing
Mean-Variance Investing
- Closed form solution for unconstrained solution
- Short selling constraint
- Minimum variance portfolio
- 1/N portfolio
- Market weights
- Risk parity
Expected Returns
- CAPM and Fama-French Model
- Alpha v.s. Beta risk
- Regression analysis
- Portfolio sorts
- Factor zoo
- AI and ML
- Market efficiency
- Behavioral economics
High-level Introduction
Present Value
where is the cash flow to be received at date , and is the rate of return associated with this stream of cash flows.
Realized v.s. Expected Returns
Realized return equal expected returns plus a shock:
where realized returns can be observed in the data.
Expected component: an investor anticipates the expected return based on historical data, models, or other forecasting methods. It represents the systematic, predictable component of returns, given the available information.
Unexpected component: the unpredictable or random component of returns, often referred to as idiosyncratic risk. This shock arises from unexpected events, news, or other unforeseen occurrences.
Models for Expceted Returns
- Capital Asset Pricing Model (CAPM):
- Fama-French model
- Factor models
- Statistical model: PCA
Two Cultures
- Structural model culture (economist): imposing fully or partially specified structural assumptions and investigating economic mechanisms through hypothesis tests.
- Prediction model culture (data scientist): values statistical explanatory power above all else and is born largely from the limitations of the earlier established structural culture.
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