Reading 23: Capital Market Expectations－LOS b capital, relation, economic, errors

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CFA Institute Area 6: Economics
Session 6: Economic Concepts for Asset Valuation in Portfolio Management
Reading 23: Capital Market Expectations
LOS b: Discuss, in relation to capital markets expectations, the limitations of economic data; data measurement errors and biases; the limitations of historical estimates; ex post risk as a biased measure of ex ante risk; biases in analysts' methods; the failure to account for conditioning information; the misinterpretation of correlations; psychological traps; and model uncertainty.

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The use of appraisal data, relative to actual returns, results in:

A) correlations that are biased upwards and standard deviations that are biased downwards.

B) correlations that are biased upwards and standard deviations that are biased upwards.

C) correlations that are biased downwards and standard deviations that are biased upwards.

D) correlations that are biased downwards and standard deviations that are biased downwards.

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Answer and Explanation

The use of appraisal data, relative to actual returns, results in correlations that are biased downwards and standard deviations that are biased downwards. The reason is that price fluctuations are masked by the use of appraised data.

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A return index that tracks the NASDAQ stock market index can be subject to:

A) survivorship bias and hence downward biased returns.

B) backfill bias and hence downward biased returns.

C) backfill bias and hence upward biased returns.

D) survivorship bias and hence upward biased returns.

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Answer and Explanation

Survivorship bias can result when a return series is based on a stock index. It will be biased upwards if the return calculation does not include firms that have been dropped from the index due to delistings.

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An analyst is forecasting the return for real estate assets. She has one year of monthly returns and would like to have enough data points for statistical purposes. Which of the following would be the most likely to result from her desire to use statistics?

A) Asynchronous data and upward biased correlations with equities.

B) Asynchronous data and downward biased correlations with equities.

C) Synchronous data and downward biased correlations with equities.

D) Synchronous data and upward biased correlations with equities.

Answer and Explanation

Her desire to use statistics would most likely result in asynchronous data and downward biased correlations. Some researchers use more frequent data (e.g., using daily instead of monthly returns) in order to increase the length of the data. This however, increases the likelihood of asynchronous data. Asynchronous data results when, for example, the return for a real estate asset is not available on a given day. The researcher then replaces it with the previous days return. When measured against equity returns with readily available daily data, the real estate asset standard deviation and correlation with equity is artificially low.