|
|
|
|
Volume 18, Number 3, Summer 2004
Symposium: Fortieth Anniversary of CAPM
The Capital Asset Pricing Model by André F. Perold
The Capital Asset Pricing Model (CAPM) revolutionized modern finance. Developed in the early 1960s by William Sharpe, Jack Treynor, John Lintner and Jan Mossin, the model provided the first coherent framework for relating the required return on an investment to the risk of that investment. This paper lays out the key ideas of the model, places its development in a historical context, and discusses its applications and enduring importance to the field of finance.
The Capital Asset Pricing Model: Theory and Evidence by Eugene F. Fama and Kenneth R. French
The capital asset pricing model (CAPM) of William Sharpe (1964) and John Lintner (1965) marks the birth of asset pricing theory (resulting in a Nobel Prize for Sharpe in 1990). Before their breakthrough, there were no asset pricing models built from first principles about the nature of tastes and investment opportunities and with clear testable predictions about risk and return. Four decades later, the CAPM is still widely used in applications, such as estimating the cost of equity capital for firms and evaluating the performance of managed portfolios. And it is the centerpiece, indeed often the only asset pricing model taught in MBA level investment courses.
The attraction of the CAPM is its powerfully simple logic and intuitively pleasing predictions about how to measure risk and about the relation between expected return and risk. Unfortunately, perhaps because of its simplicity, the empirical record of the model is poor - poor enough to invalidate the way it is used in applications. The model's empirical problems may reflect true failings. (It is, after all, just a model.) But they may also be due to shortcomings of the empirical tests, most notably, poor proxies for the market portfolio of invested wealth, which plays a central role in the model's predictions. We argue, however, that if the market proxy problem invalidates tests of the model, it also invalidates most applications, which typically borrow the market proxies used in empirical tests.
For perspective on the CAPM's predictions about risk and expected return, we begin with a brief summary of its logic. We then review the history of empirical work on the model and what it says about shortcomings of the CAPM that pose challenges to be explained by more complicated models.
Symposium: Middle East
Economic Policy and Prospects in Iraq by Christopher Foote, William Block, Keith Crane and Simon Gray
This paper describes the Coalition Provisional Authority's attempts to stabilize and reform Iraq's economy along market lines. It argues that while security concerns remain serious, Iraq's economy has not been crippled by violence. However, sustained economic growth will depend on whether Iraq's future leaders pursue the pro-market approaches the Coalition has advocated. If the Iraqi economy is to reach its potential, it will need to go even farther than the Coalition did, implementing reforms the Coalition did not pursue because of security concerns.
Why the Middle East is Economically Underdeveloped: Historical Mechanisms of Institutional Stagnation by Timur Kuran
Although a millennium ago the Middle East was not an economic laggard, by the 18th century it exhibited clear signs of economic backwardness. The reason for this transformation is that certain components of the region's legal infrastructure stagnated as their Western counterparts gave way to the modern economy. Among the institutions that generated evolutionary bottlenecks are the Islamic law of inheritance, which inhibited capital accumulation; the absence in Islamic law of the concept of a corporation and the consequent weaknesses of civil society; and the waqf, which locked vast resources into unproductive organizations for the delivery of social services. All of these obstacles to economic development were largely overcome through radical reforms initiated in the nineteenth century. Nevertheless, traditional Islamic law remains a factor in the Middle East's ongoing economic disappointments. The weakness of the region's private economic sectors and its human capital deficiency stand among the lasting consequences of traditional Islamic law.
Development, Growth and Policy Reform in the Middle East and North Africa since 1950 by Tarik M. Yousef
The September 11 terrorist attacks ignited global interest in the Middle East. Observers in the region and abroad were quick to highlight the development "deficits" in Middle Eastern countries which have been linked to everything from structural economic imbalances to deficient political systems, the curse of natural resources, and even culture and religion. This paper reviews the development history of the Middle East and North Africa region in the post-World War II era, providing a framework for understanding past outcomes, current challenges and the potential for economic and political reform.
Media, Education and Anti-Americanism in the Muslim World by Matthew A. Gentzkow and Jesse M. Shapiro
Recent surveys in the United States and the Muslim world show widespread misinformation about the events of September 11, 2001. Using data from 9 predominantly Muslim countries, we study how such beliefs depend on exposure to news media and levels of education. Standard economic theory would predict that increased access to information should cause beliefs to converge. More recent models of biased belief formation suggest that this result might hinge critically on who is providing the information. Consistent with the latter, we find that overall intensity of media use and level of education have at best a weak correlation with beliefs, while particular information sources have strong and divergent effects. Compared to those with little media exposure or schooling, individuals watching Arab news channels or educated in schools with little Western influence are less likely to agree that the September 11 attacks were carried out by Arab terrorists. Those exposed to media or education from Western sources are more likely to agree. Belief that the attacks were morally justified and general attitudes toward the US are also strongly correlated with source of information. These findings survive controls for demographic characteristics and are robust to identifying media effects using cross-country variation in language.
Articles
Where Ricardo and Mill Rebut and Confirm Arguments of Mainstream Economists Supporting Globalization by Paul A. Samuelson
Autarky real per capita well being, does not deny that new technical Chinese progress in goods that America previously had competitive advantage in can, ceteris paribus, lower permanently measurable per capita U.S. real income. Nor does it deny that technical progress in China's export goods can, ceteris paribus, hurt permanently her own net measurable per capita real income itself when demand inelasticity prevails. Ergo, the winds of dynamic comparative advantage cannot be counted on to create in each region new net gains of the gainers assuredly greater than the new net losses of the losers. However, correct Ricardian theory does imply that worldwide real income per capita does gain net, so that winners' winnings will suffice worldwide to more than compensate losers' losings--some cold comfort in a scenario of many semi-autonomous nations.
Are We Consuming Too Much? by Kenneth Arrow, Partha Dasgupta, Lawrence Goulder, Gretchen Daily, Paul Ehrlich, Geoffrey Heal, Simon Levin, Karl-Göran Mäler, Stephen Schneider, David Starrett and Brian Walker
This paper articulates and applies frameworks for examining whether consumption is excessive. We consider two criteria for the possible excessiveness (or insufficiency) of current consumption. One is an intertemporal utility-maximization criterion: actual current consumption is deemed excessive if it is higher than the level of current consumption on the consumption path that maximizes the present discounted value of utility. The other is a sustainability criterion, which requires that current consumption be consistent with non-declining living standards over time. We extend previous theoretical approaches by offering a formula for the sustainability criterion that accounts for population growth and technological change. In applying this formula, we find that some poor regions of the world are failing to meet the sustainability criterion: in these regions, genuine wealth per capita is falling as investments in human and manufactured capital are not sufficient to offset the depletion of natural capital.
Should We Fear Derivatives? by René M. Stulz
This paper discusses the extent to which derivatives pose threats to firms and to the economy. After reviewing the derivatives markets and putting in perspective the various measures of the size of these markets, the paper shows who uses derivatives and why. The difficulties firms face in valuing derivatives portfolios are evaluated. Although academics pay much attention to no-arbitrage pricing results, the paper points out that there can be considerable subjectivity in the pricing of derivatives that do not have highly liquid markets. It is shown that the known risks of derivatives portfolios can generally be measured and managed well at the firm level. However, derivatives can create systemic risks when a market participant becomes excessively large relative to particular derivatives markets. Overall, the benefits of derivatives outweigh the potential threats.
Women in Economics: Moving Up or Falling Off the Academic Career Ladder? by Donna K. Gintehr and Shulamit Kahn
The percentage of economics doctorates awarded to women has increased over the past twenty years. This article considers whether women Ph.D. economists have increased their representation in academia, particularly at higher tenured ranks. Our study draws upon several empirical approaches and multiple data sets for the 1990s. We find that when compared with other academic disciplines, women in economics are less likely to get tenure and take longer to achieve it. Although gender differences in productivity and the effect of children on promotion partly explain women's lesser chances of receiving tenure in economics, a significant portion of the gender promotion gap remains unexplained by observable characteristics.
Features
Recommendations for Further Reading by Bernard Saffran
Comments
Notes