Introduction to Risk and Return - Finance Theory, MIT Lecture 12

15.401




15.401 Finance Theory
MIT Sloan MBA Program



Andrew W. Lo
Harris & Harris Group Professor, MIT Sloan School

Lecture 12: Introduction to Risk and Return


© 2007–2008 by Andrew W. Lo

, Critical Concepts 15.401

ƒ Motivation
ƒ Statistical Background
ƒ Empirical Properties of Stock Returns
ƒ Anomalies

Readings
ƒ Brealey, Myers, and Allen Chapters 7, 24.1, 24.4




© 2007–2008 by Andrew W. Lo Slide 2
Lecture 12: Intro to Risk and Return

, Motivation 15.401


NPV and Other Valuation Techniques Need Cost of Capital
ƒ Opportunity cost
ƒ Required rate of return
ƒ Risk-adjusted discount rate
ƒ Determined by “the market”
ƒ How???

Introduce Risk Into The Valuation Process
ƒ How to measure risk
ƒ How to estimate the required rate of return for a given level of risk
ƒ Related questions:
– How risky are stocks and what have their returns been historically?
– Is the stock market “efficient”?
– How can we gauge the performance of portfolio managers?

© 2007–2008 by Andrew W. Lo Slide 3
Lecture 12: Intro to Risk and Return

, Statistical Background 15.401

Terminology




© 2007–2008 by Andrew W. Lo Slide 4
Lecture 12: Intro to Risk and Return