Anatomy of Asset Pricing: Single-Factor, Multi-Factor, Arbitrage and Behavioural Asset Pricing Models
Abwao Geofrey Magani
Magani Ochieng, Robert
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This paper reviews the development of asset pricing from Bernoulli (1738) first account of decision making under uncertainty and other ancient contributions in finance literature to the contemporary multi-factor and behavioural advances in asset pricing. The paper presents the historical development of asset pricing and derivative valuation based on the ancient literature in economics and modern financial economics on risk-return trade-off, as well as the emergence of factor models, arbitrage and behavioural asset pricing. The paper is based on an empirical review of asset pricing models in account of the chronological development with emphasis on arbitrage, single factor, multifactor and behavioural models. Besides, development of major models of asset pricing literature in which equilibrium analysis, variance optimization and no-arbitrage arguments have been eminent are reviewed. Capital asset pricing model is analysed besides the multi-factor models of asset pricing which are presented chronologically. The review accounts for the gradual shift from emphasis on market environment, valuation of individual securities and derivatives during the ancient times to the contemporary methodologies for multi-period, multi-factor and behavioural valuation of diversified assets with diverse risk-return potentials. The paper also presents a critique of various facets of asset pricing dynamics from factor models, arbitrage and behavioural asset pricing in relation to investment decisions based on the risk-return trade-off. Various approaches to securities pricing and asset valuation that influence market microstructure and investment decisions are reviewed taking note of the factor models and behavioural perspectives that continue to ellicit the discourse in the theory and practice of asset pricing. In particular, scholarly works of researchers and critiques of the factor models which are applied to securities pricing and valuation including multi-factor and behavioural asset pricing dynamics are reviewed. Nonetheless, the review shows interminable criticisms and debate on the appropriate securities pricing considerations, approach and decision model. Whereas this review recommends adoption of dynamic secirities pricing approach based on market-specific factors, conditions and circumstances, innovation and research advances should seek to overcome the challenges and weakness associated with factor-based and behavioural asset pricing models
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