Nicole Seaman

Director of CFA & FRM Operations
Staff member
Learning objectives: Describe the process of value investing and explain reasons why a value premium may exist. Explain how different macroeconomic risk factors, including economic growth, inflation, and volatility affect risk premiums and asset returns.


20.3..1. According to Andrew Ang, is it reasonable for a value strategy investor to expect excess returns?

a. No, because value is not a factor
b. No, because the historical value premium is not statistically significant
c. Yes, but the value factor is only be explained by behavioral biases
d. Yes, and the value factor might be explained by either a rational story and/or behavioral biases

20.3.2. For each of five asset classes (i.e., large stocks, small stocks, government bonds, investment grade corporate bonds, and high yield corporate bonds), Andrew Ang reported mean return and volatilities parsed by macroeconomic factors. According to this historical analysis, which of the following findings is TRUE?

a. High inflation is good for bonds
b. Because asset prices have a delayed response to factors (typically of two or three quarters), it is the level of factor that is most important
c. Over the analyzed sample period (1952:Q1 to 2011:Q4) when compared to large stocks, small stocks had higher returns and greater volatility
d. Low economic growth (aka, low real GDP growth or business cycle recession) is bad for all asset classes (i.e., large and small stocks, government and corporate bonds)

20.3.3. Volatility is an important risk factor according to Andrew Ang. The strong negative relationship between VIX changes and stock returns is explained by (at least) two dynamics. The first is called the leverage effect. The "second channel is a time-varying risk premium story and is the one the basic CAPM [capital asset pricing model] advocates," explains Ang.(†)

Assume the riskfree rate is 3.0% while the equity risk premium (EPR; aka, the market's expected excess return) is 6.0% because the market's expected return is 9.0%. According to the CAPM, and consistent with Ang's theory on the transmission channel between volatility and stock returns, which of the following should cause a DECLINE in a stock's price?

a. The VIX Index declines from 21.00 to 19.00
b. The market's volatility decreases and the stock's volatility decreases along with it
c. The stock's volatility decreases, which corresponds to an increase in its leverage via the leverage effect
d. The stock's volatility increases (along with an increase in its correlation to the market), while the market's volatility is unchanged

Answers here:

(†) Andrew Ang, Asset Management: A Systematic Approach to Factor Investing (New York: Oxford University Press, 2014).