Why do investors need a postive risk premium?
Due to the risk aversion, investors need them to be exposed in assets which tend to fall in bad times
How do Bonds an Stocks perform during inflation?
Bonds-> High inflation hurts the value of bonds, because the value auf fixed payements are decreasing
Stocks also perform poorly when inflation is high
Is there a relationship between volatility shock and return?
Yes, there is a negative relation between them. If there is a big volatitly shock, the return will decrease
Explain the correlatoin between volatility and stock returns (Leverage Effekt)
If the stock retursn drop, the financial leverage increases.
Stocks become riskier und volatilty increases.
If the Volatitly increases, the investors demand higher equity returns. This will also decline the stock return
What are prodctivity risks?
If the productivity of an assets slows down, the stock return tends toward down
How does the average investor deal with dynamic factors?
The Market Portfolio does not have dynamic factors, so the average investor does not practicing dynamic investments. The average investor is holding the market, hence is not short selling assets.
What are classic investement factors?
Small minus large (Size Premium)
Values vs growth (Value-Growth Premium)
Winning minus losing (Momentum Premium)
Define Value Stocks
Stocks with a relatively low price compared to the book values. These stocks are producing above average dividends
Define Growth Stocks
Stocks with high growth potential due to the KPIs like revenues, earings and book values. These Stocksare not producing high dividends and tend to trade to high prices compared to their book values.
What are the risks if we evaluate many factors individually?
Which statement can we make on the Size factor?
Its highly possible that we reject a true hypothesis. Also some factors could show us by chance, that they are performing superior, ecen if they dont.
The Size factor could be luck
How is the relationship between a Value stock with other Value stocks and a Value stock with growth stocks.
Value stock and Value stocks -> Positive Covariance
Value stock and Growth stock -> Negative covariance
Why is there a risk in value stocks and how do we take care of it?
Due to the high covariance to other value stock, the riskiness of value movement cannot be diversified. So we have to price the risk in equilibrium -> Value Risk Premium
How do we apply the expected returns on value and growth stocks during bad times?
Value stocks tend to lose money during bad times, so we need a high risk premium to compesate the losses -> High expected return -> more risky
Growth stocks have low returns and tend to payoff during bad times -> less risky
Why are Value Stocks riskier than Growth Stocks? (Zhang 2005)
During bad times the are
burdened with more unproductive capital (PP&E)
Grotwh stocks hold a lot of human capital and are more flexible
What is momentum investing?
When a Stock had a high return in the past the momentum investor will continue buying them so the stocks continue to go up
What is the intuition to receive a factor premium?
The Investor will hold a long and a short position from the opposite characterstic
Describe the overreaction/extrapolation hypothesis (Lakonishok, Shleifer, and Vishny, 1994)
Investors overreact on the past growth rates. Groth Firms had high rates and more investors di invest. But no Firm could be bigger than the entire market.
If the Growth stock does not peform as expected, the prices will fall. Value Investors on the opposite will outpeform
If Value Investors do outpefrom growth stocks due to the overextrapolation, why do people not invest in value stocks? (Lakonishok, Shleifer, and Vishny, 1994)
In the past, value stocks do not peform as good as growth stocks. Investors have a loss aversion and they will not invest in Value Stocks.
Value Stocks needs a Premium
What are behavioral implications of the Value factor?
An Investor who overreacts tends to growth stocks
An Investor who goes against the crowd is a Value Investor
Why is the demographic change a macro risk for equity?
For an older population, their is an excess consumption demand. They will sell their equity to fund their consumption. Therefore the equity price are declining
What are the so called “other” investment factors?
Low minus high volatitlty
Sec. with high minus low default risk
How are Value and Growth stocks perform during long run consumption Bansal et al. (2005)?
Value Stocks have a high cash-flow beta in terms of consumption
Growth Stocks have a low cash-flow beta in terms of consumption
What are rational implication for the asset owner in terms of the Value Factor?
Average Investors holds the market
Value defines Bad times and the investor should question if these are really bad times
What is the postive and negative feedback in the momentum investing?
Momentums is Positive Feedback
Stocks with high return are attractive and investor continue to buy them
Value is Negative Feedback
Stocks with declining prices are falling far enough to be considered as value stocks
What is the risk behind the positive feedback strategy in momentum investing?
This strategy may destabilze the market and results to a crash
What are Behavioral explanations for momentum investing?
Investor do not overreact good news, the prices a increasing slowly
Investor overreacht good news, there is a momentum where the price is increasing fast, but it will return to the fundamental value
Describe Hong and Stein’s (1999) under-reaction model
Informed Investor (News Watcher) receive signals about the firm value and ignore information of the past
Uninformed Investor (Momentum Trader) do not receive signals about the firm value but trade on the base of the past
Because the information are not integrated in the market prices, stocks which are already lower than the fundamental value will stay there and stocks which are already above the fundamental value. Uninformed Investor will continue buy stocks with high growth rates until it will concludde to mean reversion
realized beta is negatively related to future returns
volatility is negatively related to future returns
What is Beta against Beta? And why are Frazzini and Pedersen (2014) using it?
Low Betas had better retruns than high betas -> Violation of the CAPM
Therefore we go long with low beta stocks and short with high beta stocks.
How is the relationship between Value und Momentum investing?
There is no correlation between those factors. Therefore the returns of each factor are independent.
What is the payoff for the momentum strategy?
The Payoff for the momentum strategy is the payoff for bearing the systemtic risk. They have a big relationship, therefore if the sytematic risk is realizing, the momentum payoff is negative
What are the psychological biases from Barberis, Shleifer, and Vishny’s (1998)? Please describe them
investors underreact to to information because the stick with their beliefs -> causes momentum
Investors think high growth rates in the past will lead to high growth rates in the future -> leads to mean reversion if growth rates are not sustainable
How can we receive a volatilty premium?
We sell volatilty protection like sellung put options. But selling volatility is not a free lunch. In crash times volatility sellers suffer large losses
Describe Daniel and Moskowitz, 2016 in terms of Beta and momentum stocks
If the market declines, we go long on low betas and short high betas. But if the market is goind to rebound and will in arise again, holding the low beta stocks are not so profitable like the high beta stocks.
What are possible explanation for the low risk anomaly?
Investors buy more high beta stocks, beacause they want to receive the high returns but -> High Prices will lead to low returns
Therefore low beta stocks have low prices and high expected returns
Investors with leverage constraints bid up the price with build in leverage -> leading to flat SML