Computing Capital Asset Pricing Model with tidyquant

This note came from Matt Dancho’s webpage.

Factor models are used in many financial appplications, suhc as:

• identifying the determinants of a security’s return
• cost of capital (rate of return required by an investor to hold the share) calculations

Capital Asset Pricing Model (CAPM) is the most popular factor model. Although CAPM does not perform well in empirical testing, it’s important because it provides a starting point of many cost of capital calculations.

## # A tibble: 16,019 x 8
## # Groups:   symbol [3]
##    symbol date        open  high   low close   volume adjusted
##    <chr>  <date>     <dbl> <dbl> <dbl> <dbl>    <dbl>    <dbl>
##  1 AAPL   1990-04-30  1.40  1.42  1.39  1.41 34098400     1.14
##  2 AAPL   1990-05-01  1.42  1.43  1.41  1.42 40902400     1.15
##  3 AAPL   1990-05-02  1.42  1.43  1.40  1.42 33857600     1.15
##  4 AAPL   1990-05-03  1.42  1.44  1.42  1.43 41577200     1.16
##  5 AAPL   1990-05-04  1.43  1.46  1.40  1.43 42383600     1.16
##  6 AAPL   1990-05-07  1.42  1.49  1.42  1.48 33997600     1.21
##  7 AAPL   1990-05-08  1.46  1.5   1.46  1.49 28114800     1.21
##  8 AAPL   1990-05-09  1.49  1.5   1.47  1.50 24309600     1.22
##  9 AAPL   1990-05-10  1.49  1.49  1.45  1.48 44760800     1.20
## 10 AAPL   1990-05-11  1.48  1.53  1.46  1.52 53810400     1.24
## # … with 16,009 more rows

## # A tibble: 766 x 3
## # Groups:   symbol [3]
##    symbol date            Ra
##    <chr>  <date>       <dbl>
##  1 AAPL   1990-04-30  0     
##  2 AAPL   1990-05-31  0.0505
##  3 AAPL   1990-06-29  0.0848
##  4 AAPL   1990-07-31 -0.0615
##  5 AAPL   1990-08-31 -0.116 
##  6 AAPL   1990-09-28 -0.216 
##  7 AAPL   1990-10-31  0.0603
##  8 AAPL   1990-11-30  0.199 
##  9 AAPL   1990-12-31  0.170 
## 10 AAPL   1991-01-31  0.291 
## # … with 756 more rows

## # A tibble: 361 x 2
##    date             Rb
##    <date>        <dbl>
##  1 1990-04-30  0      
##  2 1990-05-31  0.0926 
##  3 1990-06-29  0.00719
##  4 1990-07-31 -0.0521 
##  5 1990-08-31 -0.130  
##  6 1990-09-28 -0.0963 
##  7 1990-10-31 -0.0427 
##  8 1990-11-30  0.0888 
##  9 1990-12-31  0.0409 
## 10 1991-01-31  0.108  
## # … with 351 more rows

## # A tibble: 766 x 4
## # Groups:   symbol [3]
##    symbol date            Ra       Rb
##    <chr>  <date>       <dbl>    <dbl>
##  1 AAPL   1990-04-30  0       0      
##  2 AAPL   1990-05-31  0.0505  0.0926 
##  3 AAPL   1990-06-29  0.0848  0.00719
##  4 AAPL   1990-07-31 -0.0615 -0.0521 
##  5 AAPL   1990-08-31 -0.116  -0.130  
##  6 AAPL   1990-09-28 -0.216  -0.0963 
##  7 AAPL   1990-10-31  0.0603 -0.0427 
##  8 AAPL   1990-11-30  0.199   0.0888 
##  9 AAPL   1990-12-31  0.170   0.0409 
## 10 AAPL   1991-01-31  0.291   0.108  
## # … with 756 more rows

## # A tibble: 3 x 13
## # Groups:   symbol [3]
##   symbol ActivePremium  Alpha AnnualizedAlpha  Beta `Beta-` `Beta+` Correlation
##   <chr>          <dbl>  <dbl>           <dbl> <dbl>   <dbl>   <dbl>       <dbl>
## 1 AAPL          0.0949 0.0122           0.156  1.08    1.04   1.12        0.543
## 2 GOOG          0.126  0.0115           0.147  1.02    1.06   0.889       0.557
## 3 NFLX          0.290  0.0306           0.435  1.17    1.15   0.799       0.354
## # … with 5 more variables: `Correlationp-value` <dbl>, InformationRatio <dbl>,
## #   `R-squared` <dbl>, TrackingError <dbl>, TreynorRatio <dbl>

Interpretation

• 0.0122 is the y-intercept: it means that, in the case of an actively managed portfolio, the manager provided an incremental return of 0.0122 per month beyond that of what is expected from its sensitivity to the benchmark. In the case of a sinlge stock, however, the y-intercept captures part of the return that is not captured by the overall market movement but rather attributed to the individual stock.
• 1.0819 is the beta:
  • It measures how sensitive the stock’s return is to the movement of the overall market. It means that, if the market goes up by 1%, we expect the stock to go up by 1.0819%. A beta less than one is considered defensive stocks as these stocks are less affected by adverse market movements.
  • It is also used to calculate the cost of equity (rate of return required by an investor to hold the company’s share). \(cost of equity = Yintercept + beta * ERP\) The general range of Equity Risk Premeum (ERP) is 5-8%.

Q1 Import stock prices of Apple, Microsoft and Amazon for the last 20 years.

## # A tibble: 15,090 x 8
## # Groups:   symbol [3]
##    symbol date        open  high   low close    volume adjusted
##    <chr>  <date>     <dbl> <dbl> <dbl> <dbl>     <dbl>    <dbl>
##  1 AAPL   2000-04-28  4.54  4.55  4.33  4.43  62395200     3.85
##  2 AAPL   2000-05-01  4.46  4.47  4.35  4.44  56548800     3.85
##  3 AAPL   2000-05-02  4.40  4.51  4.20  4.21  59108000     3.65
##  4 AAPL   2000-05-03  4.25  4.33  3.99  4.11 122449600     3.57
##  5 AAPL   2000-05-04  4.11  4.12  3.95  3.95  99878800     3.43
##  6 AAPL   2000-05-05  3.96  4.10  3.95  4.04  71019200     3.51
##  7 AAPL   2000-05-08  4.00  4.06  3.93  3.93  46225200     3.41
##  8 AAPL   2000-05-09  3.94  3.97  3.75  3.77  81785200     3.27
##  9 AAPL   2000-05-10  3.72  3.75  3.53  3.55 133772800     3.08
## 10 AAPL   2000-05-11  3.62  3.72  3.54  3.67 124936000     3.19
## # … with 15,080 more rows

Q2 Calculate monthly returns.

## # A tibble: 723 x 3
## # Groups:   symbol [3]
##    symbol date            Ra
##    <chr>  <date>       <dbl>
##  1 AAPL   2000-04-28  0     
##  2 AAPL   2000-05-31 -0.323 
##  3 AAPL   2000-06-30  0.247 
##  4 AAPL   2000-07-31 -0.0298
##  5 AAPL   2000-08-31  0.199 
##  6 AAPL   2000-09-29 -0.577 
##  7 AAPL   2000-10-31 -0.240 
##  8 AAPL   2000-11-30 -0.157 
##  9 AAPL   2000-12-29 -0.0985
## 10 AAPL   2001-01-31  0.454 
## # … with 713 more rows

Q3 Import baseline prices and calculate its monthly return.

## # A tibble: 241 x 2
##    date            Rb
##    <date>       <dbl>
##  1 2000-04-28  0     
##  2 2000-05-31 -0.119 
##  3 2000-06-30  0.166 
##  4 2000-07-31 -0.0502
##  5 2000-08-31  0.117 
##  6 2000-09-29 -0.127 
##  7 2000-10-31 -0.0825
##  8 2000-11-30 -0.229 
##  9 2000-12-29 -0.0490
## 10 2001-01-31  0.122 
## # … with 231 more rows

Hint: Use NASDAQ Compsite Index as baseline.

Q4 Merge the two sets of monthly returns.

## # A tibble: 723 x 4
## # Groups:   symbol [3]
##    symbol date            Ra      Rb
##    <chr>  <date>       <dbl>   <dbl>
##  1 AAPL   2000-04-28  0       0     
##  2 AAPL   2000-05-31 -0.323  -0.119 
##  3 AAPL   2000-06-30  0.247   0.166 
##  4 AAPL   2000-07-31 -0.0298 -0.0502
##  5 AAPL   2000-08-31  0.199   0.117 
##  6 AAPL   2000-09-29 -0.577  -0.127 
##  7 AAPL   2000-10-31 -0.240  -0.0825
##  8 AAPL   2000-11-30 -0.157  -0.229 
##  9 AAPL   2000-12-29 -0.0985 -0.0490
## 10 AAPL   2001-01-31  0.454   0.122 
## # … with 713 more rows

Q5 Calculate performance metrics, CAPM measures.

## # A tibble: 3 x 13
## # Groups:   symbol [3]
##   symbol ActivePremium  Alpha AnnualizedAlpha  Beta `Beta-` `Beta+` Correlation
##   <chr>          <dbl>  <dbl>           <dbl> <dbl>   <dbl>   <dbl>       <dbl>
## 1 AAPL          0.197  0.0188          0.251  1.20    1.11    1.31        0.638
## 2 MSFT          0.0661 0.0069          0.0864 0.867   0.594   0.998       0.679
## 3 AMZN          0.165  0.0174          0.231  1.34    1.34    1.50        0.616
## # … with 5 more variables: `Correlationp-value` <dbl>, InformationRatio <dbl>,
## #   `R-squared` <dbl>, TrackingError <dbl>, TreynorRatio <dbl>

Q6 Interpet the alpha.

.0122 estimated alpha for apple. Has done postive over last 3 decades. All 3 stocks were positive on market.

Q7 Interpret the beta.

The BEta is 1.17 % for NFLX which is the riskiest stock and apple is the least risky with 1.02%.

Q8 Hide the messages and the code, but display results of the code from the webpage.

Hint: Use message, echo and results in the chunk options. Refer to the RMarkdown Reference Guide.

Q9 Display the title and your name correctly at the top of the webpage.

Q10 Use the correct slug.