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Modelling alpha in a CAPM with heterogenous beliefs


Hens, Thorsten; Gerber, Anke (2017). Modelling alpha in a CAPM with heterogenous beliefs. Journal of Finance & Economics, 5(2):1-21.

Abstract

The alpha is one of the most used terms in finance. Yet, the alpha is mystical since it has no theory. It is, for example, in contradiction to the standard CAPM with homogenous beliefs. The purpose of this paper is to show that the alpha naturally arises in a financial market equilibrium when the CAPM is extended to heterogenous beliefs. We show that the hunt for alpha-opportunities is a zero-sum game and that alpha-opportunities erode with the assets under management. Moreover, it is shown that a positive alpha is not necessarily a good criterion for the choice between active and passive investment. Finally, we argue that the standard CAPM with homogenous beliefs can be seen as the long run outcome of our model when investors' expectations are linked to the trading success.

Abstract

The alpha is one of the most used terms in finance. Yet, the alpha is mystical since it has no theory. It is, for example, in contradiction to the standard CAPM with homogenous beliefs. The purpose of this paper is to show that the alpha naturally arises in a financial market equilibrium when the CAPM is extended to heterogenous beliefs. We show that the hunt for alpha-opportunities is a zero-sum game and that alpha-opportunities erode with the assets under management. Moreover, it is shown that a positive alpha is not necessarily a good criterion for the choice between active and passive investment. Finally, we argue that the standard CAPM with homogenous beliefs can be seen as the long run outcome of our model when investors' expectations are linked to the trading success.

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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:7 August 2017
Deposited On:19 Feb 2018 20:57
Last Modified:15 Mar 2018 16:18
Publisher:Science and Education Centre of North America
ISSN:2291-4951
OA Status:Hybrid
Free access at:Publisher DOI. An embargo period may apply.
Publisher DOI:https://doi.org/10.12735/jfe.v5n2p01
Other Identification Number:merlin-id:15435

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