According to asset pricing theory, non-diversified investors should require, all other factors being equal, a higher expected return on their investments than diversified investors. Furthermore, a five-factor model by Fama-French (2016) that adds profitability and investment factors to the three-factor model of Fama-French suggests a shared story for several average return anomalies. Recent research argues that ex ante (implied) cost of equity derived from earnings forecasts is based on strong criticisms that have been forwarded against realised returns.
Discuss finance theory and recent developed models in Asset Pricing. Critically provide an argument on the implications of Fama-French models and why and how can Implied Cost of Equity approach explain the variations in the expected stock returns.
References
Fama, E.F. and French, K.R., 2016. Dissecting anomalies with a five-factor model. The Review of Financial Studies, 29(1), pp.69-103.
This assignment requires you to
1. How
2. How the CAPM’s empirical problems may reflect theoretical failings, the result of many simplifying assumptions.
3. What drives expected stock returns? To capture these return patterns, various multifactor models have been suggested by Fama and French.
4. How ex ante cost of equity implied in analyst’ earnings forecasts and stock prices allows us to overcome the limitations associated with using traditional Asset Pricing Models
References
Fama, E.F. and French, K.R., 2016. Dissecting anomalies with a five-factor model. The Review of Financial Studies, 29(1), pp.69-103.
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