Question

1. Work in empirical asset pricing has studied portfolios where stocks are grouped together on the basis of a ‘value’ measure (e.g. book-to- market value or earnings per share divided by price per share). What is the evidence on how mean returns vary across such portfolios and why does this provide a challenge to the Capital Asset Pricing model? How would you interpret the existence of differences in mean returns across value portfolios? [Write no more than 15 sentences in your answer.]

Answer 1

Mean return may vary across portfolios as they are containing such stocks which are grouped together on the basis of their value measures and the variation among such stocks would be very high even if they are almost similar portfolio in nature, which have risk of similar nature and they are highly diversified and they have been allocated into representatives of difference sectors.

According to the Capital Asset pricing model expectation relating to these portfolio have been of very similar nature because this portfolios are almost having similar risk exposures and similar constituent in terms of assets which are of value based but the return from the mean have been extremely deviating so can we say that standard deviation is high.

differences in mean return could be attributed to the performance of various stocks even if, there is similarity in there risk exposures, but they are driven by their own form specific features and hence and an investor needs to be highly sceptical in selection of stocks.