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  • CAPM - Sum Revised

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    Yanee Ree
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    The document discusses the capital asset pricing model (CAPM). It outlines that CAPM is based on assumptions of rational investors aiming to maximize utility, access to risk-free borrowing and lending, and perfect competition. The document also notes CAPM has been critiqued and that information asymmetry can undermine some of its assumptions by introducing estimation risk for investors.

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    CAPM.sum Revised

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    The document discusses the capital asset pricing model (CAPM). It outlines that CAPM is based on assumptions of rational investors aiming to maximize utility, access to risk-free borrowing and lending, and perfect competition. The document also notes CAPM has been critiqued and that information asymmetry can undermine some of its assumptions by introducing estimation risk for investors.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Flag for inappropriate content
    25 views19 pages

    CAPM - Sum Revised

    Uploaded by

    Yanee Ree
    The document discusses the capital asset pricing model (CAPM). It outlines that CAPM is based on assumptions of rational investors aiming to maximize utility, access to risk-free borrowing and lending, and perfect competition. The document also notes CAPM has been critiqued and that information asymmetry can undermine some of its assumptions by introducing estimation risk for investors.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Flag for inappropriate content
    of 19

    4.

    5 A MODEL OF COST OF CAPITAL

    A Capital Asset Pricing Model


    (CAPM)
    A MODEL OF COST OF CAPITAL

    1 A Capital Asset Pricing


    Model(CAPM)
    • Relationship between the
    2 Three main uses for CAPM efficient market price of security,
    risk, and the expected rate of
    return
    3 CAPM Model
    • Sharpe-Lintner capital asset
    pricing model
    4 Critique of CAPM
    A MODEL OF COST OF CAPITAL

    1 A Capital Asset Pricing


    Model(CAPM)

    2 Three main uses for CAPM

    3 CAPM Model

    4 Critique of CAPM
    A MODEL OF COST OF CAPITAL

    1 A Capital Asset Pricing


    Model(CAPM)

    2 Three main uses for CAPM

    3 CAPM Model

    4 Critique of CAPM
    A MODEL OF COST OF CAPITAL

    1 A Capital Asset Pricing


    Model(CAPM)

    2 Three main uses for CAPM

    3 CAPM Model

    4 Critique of CAPM
    A MODEL OF COST OF CAPITAL

    1 A Capital Asset Pricing


    Model(CAPM)

    2 Three main uses for CAPM

    3 CAPM Model

    4 Critique of CAPM
    A MODEL OF COST OF CAPITAL

    1 A Capital Asset Pricing


    Model(CAPM)

    2 Three main uses for CAPM

    3 CAPM Model

    4 Critique of CAPM
    A MODEL OF COST OF CAPITAL

    1 A Capital Asset Pricing


    Model(CAPM)

    2 Three main uses for CAPM

    3 CAPM Model

    4 Critique of CAPM
    A MODEL OF COST OF CAPITAL

    1 A Capital Asset Pricing


    Model(CAPM)

    2 Three main uses for CAPM

    3 CAPM Model

    4 Critique of CAPM
    A MODEL OF COST OF CAPITAL

    1 A Capital Asset Pricing


    Model(CAPM)

    2 Three main uses for CAPM

    3 CAPM Model

    4 Critique of CAPM
    A MODEL OF COST OF CAPITAL

    1 A Capital Asset Pricing Assumptions;


    Model(CAPM)
    1.All investors are rational risk averse investor.
    2.All investors aim to maximize economic
    2 Three main uses for CAPM utilities.
    3.All investors are able to lend and borrow at
    risk-free rate.
    3 CAPM Model 4.Perfect Competitive
    - no taxes
    - no transaction fee
    4 Critique of CAPM - no asymmetric information
    A MODEL OF COST OF CAPITAL

    1 A Capital Asset Pricing


    Model(CAPM) 1.All investors are rational risk averse investor.

    2 Three main uses for CAPM


    See the detail in Chapter6

    3 CAPM Model

    4 Critique of CAPM
    A MODEL OF COST OF CAPITAL

    1 A Capital Asset Pricing


    Model(CAPM) 2.All investors aim to maximize economic
    utilities.
    2 Three main uses for CAPM

    3 CAPM Model

    4 Critique of CAPM
    A MODEL OF COST OF CAPITAL

    1 A Capital Asset Pricing


    Model(CAPM) 3.All investors are able to lend and borrow at
    risk-free rate.

    2 Three main uses for CAPM

    3 CAPM Model

    4 Critique of CAPM
    A MODEL OF COST OF CAPITAL

    1 A Capital Asset Pricing


    Model(CAPM) 4.Perfect Competitive

    2 Three main uses for CAPM

    3 CAPM Model

    4 Critique of CAPM
    4.6 INFORMATION ASYMMETRY
    A CLOSER LOOK AT INFORMATION ASYMMETRY

    • Adverse selection
    • When one type of participant in the market knows
    something about the asset being traded that another type
    of participant does not know
    • The unknown parameter is the honesty of the insider.
    • Moral hazard
    • Manager effort in running the firm is typically
    unobservable, creating the possibility that the manager may
    shirk on effort
    • The unknown parameter is the extent of manager shirking.
    In the face of information asymmetry
    A CLOSER LOOK AT INFORMATION ASYMMETRY

    • Inside information a source of estimation risk for investor

    • Investor reaction to estimation risk


    • The lemons problem (Akerlof (1970))

    • Effect to a share in the presence of inside information


    • Investors might withdraw from market, market collapse
    • Investors pay less, to protect against estimation risk
    A CLOSER LOOK AT INFORMATION ASYMMETRY

    • Effect of estimation risk on share prices

    • Efficient market price includes a “discount” for


    estimation risk i.e., investors demand a higher return

    • CAPM understates cost of capital, since ignores


    estimation risk

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