CFA CFA Level 2 Return and Risk premium models – how do navigate it all?

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

  • This topic has 2 replies, 2 voices, and was last updated Apr-18 by Stuj79.
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    • Prosper0
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      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?

    • Prosper0
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      Nobody to chip in with their views?

    • Stuj79
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      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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