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Return and Risk premium models - how do navigate it all?

I think the title speaks for itself, there is just so much of it!

Things that are confusing me - what risk free rate to use. I got burnt by 2 questions in one item set from Kaplan (I think it was Portfolio management rather than Equity but no matter) where they asked to calculate risk premium - one from APT model and the other one from macroeconomic factor. There were 2 risk free rates given (TBills and Tbonds or some such, basically a short-term and long-term rf rates) and for some reason each question used a different risk free rate. Why? I don't get it? Are some of the models explicitly more short term than others?

Also, one on CAPM. Now thanks to my background, I am pretty on CAPM and econometrics in general. What I dont get is how to distinguish between the following 2 applications:

1) Ri=alpha + beta*RM
2) Ri=rf + beta*MRP, where MRP = RM-rf

Any ideas?

Also, what are managing to learn all the different models and their applications?



Comments

  • Prosper0Prosper0 PraguePosts: 25 Sr Associate
    Nobody to chip in with their views?
  • As far as I am aware:

    CAPM = Long-term Govt Yield

    BYPRP = Long-term firm yield

    Fama French = Short-term Yield

    Pastor Stanbaugh= Short-term yield

    Ibbotson Chen = Supply Side = Not specified in the CFAI curriculum

    BIRR = Short-term yield

    GGM = Long-term yield

    To answer your second question I THINK it is as follows:

    1) This is the output of a linear regression model using historic data to quantify the stock's relationship to market returns - with "alpha" being the stock specific return expected when the market return is zero, and "beta" being the slope coefficient between the market returns and stock returns

    2) This is a forward looking "ex ante" model of expected returns based on the specific CAPM theory. It doesn't include an "alpha" as there is no historical regression.

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