Eric Falkenstein

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 James H. Lorie and Lawrence Fisher created dataset of stocks from 1926-1964 in US  Theory and data would now show us something new, true, and important  “If I had to rank events, I would say this one (the original CRSP Master File) is probably slightly more significant than the creation of the universe“ Rex Sinquefeld

  Sharpe (1965) 

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Sharpe (1966) 

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 Treynor and Mazuy (1966)

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 Jensen (1968) 

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 Find variance more important than beta

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2    Miller and Scholes (1972) Check for       Beta measurement errors Market proxy Nonnormality Skewness, Heteroskedasticity Changing interest rates No size, delisting issues

 1971 Institutional Investor :“The Beta Cult: The New Way to Measure Risk.”  Contrast with Efficient Markets Hypothesis

 High beta stocks will have positive beta bias   ~

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  1  ˆ 1    ˆ  1 Sort by beta from 1929-1933  Form 20 portfolios  Estimate beta of portfolio from 1933-39 using monthly data  Use beta to examine month-ahead returns

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 Black, Jensen and Scholes (1972), Blume and Friend (1973), Fama and MacBeth (1973),

 Real testable hypothesis of the CAPM that the market is mean-variance efficient  Given investor preferences, CAPM must hold if true  Market includes real estate, human capital, so S&P500 not ‘the market’  Untestable

 Basu (1977), Statman (1980)

 Note relation to Beta

 the January effect  September effect  Monday effect  Friday effect  days before holidays  Returns only positive if use first half of each month

 Low-price effect  3 year over-reaction (DeBondt and Thaler)  Accruals (noncash earnings)  Capital issuance  R&D expenditures  Momentum  Earnings announcement drift  Index additions  Dividend effects  Momentum (past 12 month’s return)

 Chen, Roll, and Ross (1986) 1.

Industrial Production change 2.

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BBB and AAA yield spread Long term-short term yield spread Unanticipated inflation Anticipated inflation, The market

 Connor and Korajczyk  Find factors using factor analysis  First Factor looks like the Equal Weighted Equity Index  Second factor ???

 Third factor ???

 Zero-beta, not risk free, asset

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  Jointly estimating parameters  Exact finite sample distributions  Gibbons (1982) ,Shanken (1985), Gibbons, Ross, and Shanken (1989)  reject CAPM at p-value 0.001

      Big deal No big deal

 Maximum Likelihood, Lagrange Multiplier, Wald Tests  Has it ever mattered?

 Discriminate Analysis, Logit, Probit  continuous time vs discrete time finance  ‘ordinary’ Least Squares, 2-stage LS, 3-stage SLS

 1950 Cowles Group: Simultaneity, FIML  1950 Durbin & Watson serial correlation  1953 Theil: 2 Stage Least Squares  1960 Chow Test for Structural Change  1974 Heckman: self-selection  1974 McFadden et al: discreet choice  1978 Hausman: exogeneity test  1979 Godfrey-Breusch-Pagan-Bera: LM test  1981: non-stationarity and cointegration  1982 Engle: ARCH  1982 Hansen: GMM

    Bad wine < good wine > fancy wine $7 bottle < $30 bottle > $200 bottle Secrets to good wine: sanitation, harvest time Irrelevancies: fine terroir distinctions, charred French oak barrels      Bad statistics < good statistics > fancy statistics Univariate correlations < OLS > 2SLS Good Stats: control for omitted variables, clean data of mistakes Irrelevancies: asymptotics, GMM, joint estimations Abominations: back-fitting VARs, interaction terms,

 Synthesize anomalies and failure of CAPM  Show beta is just a size effect  Founding father (Fama) admits CAPM wrong

1927-2008 AnnRet AnnStdev Beta Mkt-Rf 7.64

21.01

SMB 3.56

14.37

0.28

Value HML 5.16

14.05

0.08

1983-2008 AnnRet AnnStdev Beta 6.48

17.78

0.58

11.66

0.07

SMB: Small minus Big Size HML: High minus Low Book/Market UMD: Up minus Down Stocks (Past 12 Month Return)

5.77

14.93

-0.23

Mo UMD 7.50

15.82

-0.07

5.31

13.71

-0.22

 Arithmetic Averaging of daily returns:  1, 1.5, 1  +50%, -33%  Arithmetic avg=8%, Geometric avg=0%  Delistings  Shumway finds delisted firm monthly returns -55% on Nasdaq  Size Index: 1% increase from 1993 through 2009  Value Index: 4% premium from 1975 through 2009

 Jagannathan and Wang (1993): per capita labor income (year-over-year)  Lettau-Ludvigson (2000): consumption, assets, and income, Vector Auto Regression  Campbell and Vuolteenaho (2002): Beta from CF and discount factor, VAR from size, yield curve, P/E ratio  ‘good beta/bad beta’

 Size, Value, Momentum related to returns  Not clear why, or if real  Beta not related to returns  Delistings, daily returns, bias annual returns  Most Anomalies—e.g., calendar effects---ephemeral or spurious  Sophisticated tests have been distractions (e.g., GMM)