Chapter 19 EXTENSIONS OF CAPITAL ASSET

PRICING THEORY

• What is the zero-beta portfolio model?

• What are some results of empirical tests of the capital asset pricing model?

• What is Roll’s critique of the capital asset pricing model?

• What is the arbitrage pricing theory?

Modifications of the CAPM

• Zero-Beta Portfolio.

• Zero-Beta Portfolio Model.

Figure 19.1 – Zero-Beta Portfolio Model

Figure 19.2 – Risk/Return Relationship for Zero-Beta Portfolio Model

Empirical tests and critique of the CAPM

• Empirical tests– Joint hypothesis testing– Procedure of empirical tests– Empirical results

Empirical tests and critique of the CAPM-Cont.

• Critique of the CAPM– Limits on tests– Linear risk/return relationship–Market portfolio composition– Range of SMLs–Market efficiency effects– Conflicts between proxies

Figure 19.3 – Empirical Findings for the CAPM

Figure 19.4 – Empirical Findings for the CAPM: Apr 1957-Dec 1965

Figure 19.5 – Different Well-Diversified Portfolios and Their Corresponding SMLs

Arbitrage Pricing Theory

• Concept of Arbitrage

• Single-Factor APT– Single-factor APT for a well-diversified

portfolio– Example of Exhibit 19.6

• Development of the single-factor APT

Arbitrage Pricing Theory – Cont.

• Differences between the single-factor APT and the CAPM

• APT with multiple factors– Two-factor APT– N-factor APT

• Final synopsis of APT

• Implications for Investors

Figure 19.6 – Arbitraging Portfolio K Using Portfolio CD