Monday, December 29, 2014

How Scientific Progress Happens: CAPM Case Study

Falky on the rise and fall of bogus CAPM theory in finance.

  • Profits and thus stock returns were a mystery up to 1950
  • Risk begets return theory developed 1947-62 (CAPM)
  • CAPM assumed true 1962-1992
  • CAPM shown incomplete 1992+
  • Low vol anomaly 2006+

1 comment:

High Plateau Drifter said...

If you look at stocks that have high volatility because they are falling rapidly, then high volatility is predictive of future appreciation and "out performance". However, you must wait until the the volatility (downward momentum) declines before buying them. Examples right now are commodity producers, oil, gold miners, etc.

It is the phase transition from high to lower volatility that must be measured and watched. You don't want to buy into a violent upside surge coming out of a downside crash but rather wait for a lower low with a higher low in the MACD, for declining put premiums, or any number of other indicators that good technicians and chart watchers use.

High volatility is an excellent guide to profits when used to select short positions of the high flyer story stocks (as their volatility decreases) or to go long the crash victims (as their volatility decreases).

In short, high volatility is a precursor of gains if one has the patience to lurk in the brush like a panther waiting to strike at weakened (volatility) prey.

But as a single time and price independent variable (allowing one to be invested at all times) it will be a loser as the recent research suggests.