Recall the general notes you received when we handed out your assignment It is important that you read the two articles before you start writing your essay. These articles provide excellent background to the topic (hortcomings of Capital Asset Pricing Model(CAPM) ?回想收到我們給你的任務是很重要的前提，你讀你開始寫你的文章的前兩篇文章的一般注意事項。這些文章提供了很好的背景主題
We would like to recall again the essential points listed in that handout

我們想再次回顧，講義中所列的要點
解決提出的問題 - 不要偏題
這樣我們不能給你通過，如果你改變了問題。
引用任何你使用的材料在你的dissertation中，這是不是你的- 寫的引用（這應該弄清楚的文章快結束的時候（從而結束后）是一個很好的方法如下：

address the QUESTION ASKED - DO NOT CHANGE THE QUESTION! WE CAN NOT GIVE YOU MARKS IF YOU CHANGE THE QUESTION.
REFERENCE ANY MATERIAL YOU USE IN YOUR ESSAY WHICH IS NOT YOURS
– A good way of writing up the references (which should figure at the VERY END of the essay (thus after the conclusion) is as follows:
 For article references you can use:
Family name of author, First name of author (1988) ‘The use of sunshine in thinking’, Journal of Sunshine Studies, vol. 20, pp.
1–20.
 For book references you can use:
Family name of author, First name of author (1988) The revolving earth, Ohio: Wonderful Publishers.
You can use numbers in your essay to reference you work. For instance: the first reference you use, you could denote as [1] and then [1] you list in the reference list at the end of the essay (after the conclusion).
– For further examples refer to the programme handbook.
THIS IS NOT AN ESSAY WHICH CONTAINS only A LIST OF THINGS! WE ARE ASKING YOU TO ‘CRITICALLY REVIEW AND DISCUSS’. Clearly there is a review element in your essay, where you will list facts and theories - but you need to discuss the CAPM model and empirical approaches to est it. USE YOUR IDEAS! DO NOT BE AFRAID
IN DOING SO!
– PLEASE try to use journals as reference sources. Financial thesis Textbooks, for graduate work, are a less useful source - when used in a scholarly essay.
If you think you can understand the content of an article by going through a first read only...then you are probably mistaken
• Academic articles have to be read several times and each time you read the article you will add something ‘more’ to your understanding.
• Highlight things you think are important in the article - do not get bogged down on the algebra in a first sweep of the article! You may want to try to understand the general idea in a first reading-sweep, but subsequent reading sweeps should help you in detailing more your understanding.#p#分頁標題#e#
• WHILE READING KEEP IN MIND THE RESEARCH
QUESTION YOU ARE BEING ASKED TO ADDRESS IN
OTHER WORDS - WHAT ELEMENTS CAN YOU USE FROM THE ARTICLE WHICH ARE RELEVANT TO THE REVIEW (AND DISCUSSION) OF THE TOPIC OF CAPM SHORTCOMINGS
Remember the topic of the essay:Discuss the shortcomings of Capital Asset Pricing Model (CAPM) and its relation with Arbitrage Pricing Theory (APT).
• None of the two articles deal with Arbitrage Pricing Theory
• None of the two articles deal with the relationship between CAPM and APT
• Need to review more papers discussing the shortcomings of CAPM, and also review papers relating CAPM to APT!
• Basing your essay solely on both articles will lead to a fail! Roll, R. (1977) ‘A critique of the asset pricing theory’s tests’, Journal of Financial Economics, vol. 4, pp. 129–176.
1. The main message usually taken from this paper is that CAPM tests depend on the knowledge of the market’s portfolio. The problem is that this is not known.
2. The paper starts by describing the main findings:
3. See page 129: ‘No correct and unambiguous test of the theory has appeared in the literature’ and ‘there is practically no possibility that such a test can be accomplished in the future’
4. The author claims that ‘[t]here is only a single testable hypothesis
associated with’ CAPM: ‘the market portfolio is mean-variance efficient’. See page 130.
5. The linearity of the expected returns implied by the model depends on the market portfolio efficiency. Hence can’t be tested independently. See page 130.
6. An alternative is to use a proxy for the market portfolio. The author explores the difficulties of doing so in pages 130–1.
7. A complete review of the CAPM model and associated results is given in the appendix and pages 133–135. (We will derive most of these results in the lectures)
8. For instance, Figure 1 in page 141 presents the portfolio frontier, zero covariance portfolios and risk free asset return. All this is going to be addressed in the lectures.
9. The paper continues with an extensive analysis and discussion of the several tests performed by other authors, especially:
• Black, F., Jensen, M. C. and Scholes, M. (1972) ‘The capital asset pricing model: some empirical tests’, in M.C. Jensen (Ed), Studies in Theory of Capital Markets. New York: Praeger.
• Blume, M.E. and Friend, I. (1973) ‘A new look at the capital asset pricing model’, Journal of Finance, vol. 28, pp. 19–34.
• Fama, E.F. and MacBeth, J.D., 1973, ‘Risk, return and equilibrium: Empirical tests’, Journal of Political Economy, vol.81,pp. 607–636.
Several econometric problems are revealed. The discussion leads to the general conclusion that it is not possible to correctly test hypotheses  on the CAPM model.#p#分頁標題#e#
10. Final main conclusions:
• Testing the CAPM equation, i.e. the linearity of the mean return,is (mathematically) equivalent to test the mean-variance efficiency of the market portfolio. Hence, if we assume that the market portfolio is efficient then CAPM must be true.
• The market portfolio must include the returns on ALL assets
(including real estate, every asset with value, etc). Returns on all assets are unobservable and hence the market portfolio is unobservable. CAPM is not testable.
Banz, R. W. (1981) ‘The relationship between return and market
value of common stocks’, Journal of Financial Economics, vol. 9,
1. This paper ‘examines the relationship between the total market value of the common stock of a firm and its return.’ See page 3.
2. The analysis in the paper shows that ‘common stock of small firms had, on average, higher risk-adjusted returns than the common stock
of large firms’. See pages 3–4. The author call this phenomena the‘size effect’.
3. This finding is evidence against the linear relationship between expected return and market risk assumed by CAPM. Why?
4. The methodology consists on considering a model which is an extension of CAPM incorporating one term accounting for firm market size. See page 4.
5. In the methodology section, pages 4–6 the author discusses alternative possible methodologies used in previous studies.
6. Note on page 6 the reference to Roll’s (1977) critique. This is the motivation for using a composed ‘market index’ trying to overcome the critique.
7. On page 8 the author concludes that there is empirical evidence of a‘size effect’: ‘shares of firms with large market values have had smaller returns, on average, than similar small firms.’
8. The author concludes that ‘The CAPM appears to be misspecified.’See page 8. What is a misspecified model?
9. The article continues with robustness tests.
10. A second finding with implications for the validity of CAPM is on page
11. A residual analysis shows that ‘the linear model is misspecified.’
11. This has consequences for the use of the size coefficient estimated for the linear model as a size premium. See page 11.
12. Nevertheless, the size coefficient is still significant as explained and tested in pages 12–13.
13. This non-linearity results in the fact that the size effect is more significant for very small firms (in terms of market cap). See page 12.
14. But is the difference in returns between portfolios with different market cap significant in practice? See page 13?4 for the answer.
15. The answer is yes especially between very small firms and medium or large firms. The authors point for diversification problems if an investor tries to explore this effect in a portfolio strategy. See page 16.
16. The paper ends with a summary of the main findings: (page 16)#p#分頁標題#e#
There is a size effect
CAPM is misspecified
The size effect is not linear in the market cap being more
significant for firms with small market cap
The size effect is time varying
17. Note the remarks about the lack of a theoretical model for the size effect on page 16.
18. If size effect exists then this has consequences on tests for market efficiency based on CAPM. See page 17.
19. Finally, remark the link between the information available for small and large firms and larger and smaller average returns respectively.See page 17.
Any essay will need to contain THREE SECTIONS:
A) Introduction
– where you introduce the reader - us!! - to what you will be writing about. You may be highlighting some of the essential issues in the introduction. Lots of journal articles contain this type of information in their introduction section of their paper
– Note that many journal articles will also contain a so called ‘abstract’ - which is a very condensed summary of the essential results of the journal article.
– The introduction is NOT the abstract! The introduction of an essay - article - is meant to guide the reader - in a gentle way
- to what is to come next. We will be trying to write an introduction in the groups, or at least to collect ideas you could use in the introduction.
B) Main body of the essay and conclusion
– here you will provide for the discussion of the topic of your essay. In your case you need to review and discuss and those two operations are to happen in the main body of your essay.
PLEASE try not to discuss and review in the conclusion of your paper. The conclusion of your paper concludes and will not provide for new information.
– please give a title to the main body of your essay! For instance: ‘From CAPM to APT: a review’
– the main body of your essay may contain subsections. Say the main body is: ‘II. A review of efficiency’. Before you have ‘I.
Introduction’. Finally ‘III. Conclusion’. The main body can contain a subsection ‘II.1. Shortcomings of CAPM’...etc...
Distribution of groups
• Separate now into small groups of about 5 individuals each
• Take a piece of paper and start discussing what you will be writing in the introduction of your paper. Write this down
• I will see group 1 first, then group 2...and I then will re-visit group 1, 2....
• Now - what elements will you include in the main body of your essay? For instance, what sub-titles do you envisage using?Discuss the ideas you have relative to the topic of CAPM shortcomings and APT.