Question

I am not sure what is the difference between asset pricing model and single index model. Meanwhile, I am a little bit confused about the common fund, mutual fund and hedge fund.

Answer 1

Asset pricing model:

Asset pricing model is considered to be a general equilibrium model which is based on microeconomic ideas like concave utilities, costless diversification etc. this makes an exact prediction about the expected return i.e.

E (Ri) = Rf + beta-of-i * (Rm - Rf)

Or equivalently:

Ri = Rf + beta-of-i * (Rm - Rf) + ei where ei is an error term and E (ei) = 0

The asset pricing model may or may not be true. It mainly depends upon the validity of its assumptions that is almost certainly not true.

Single pricing model:

This is simply a form of correlation equation between two variables namely (Ri - Rf) and (Rm - Rf). This must always be true & this tells a lot less than the asset pricing model. Specifically this doesn’t say anything about the magnitude of the expected return.

Ri - Rf = alpha-of-i + beta-of-i * (Rm - Rf) + ei

• Common fund: this is a form of collective investment scheme that is based upon contractual law rather than being enacted through a trust, corporation or an insurance policy.
• Mutual fund: this is a professionally managed investment fund that pools money from many investors to purchase securities. The investors may be retail or institutional in nature. The major advantages of mutual fund is that they provide economies of scale, high level of diversification, liquidity & are managed by professional investors.
• Hedge fund: this is an investment fund that pools capital from accredited or institutional investors & invests in a variety of assets. Hedge funds are made available only to certain sophisticated or accredited investors, and cannot be offered or sold to the general public.[1] As such, they generally avoid direct regulatory oversight, bypass licensing requirements applicable to investment companies, and operate with greater flexibility than mutual funds and other investment funds