Hello, everyone. I'm Dr. O and I would like to welcome you back to module 5 and the final module of our course. Thanks for joining us again. In this module, we're going to be talking about asset pricing models. How should asset prices be determined in an equilibrium? In other words, what should determine the expected returns in equilibrium? So, throughout this course we've been building analytical tools to measure risk, and evaluate risk, and return trade off. So by now, you all know that risk needs to be rewarded. But exactly how much? So in this module, we're going to build on the foundation of modern portfolio theory. As we have seen, right, diversification eliminates some but not all of the risk. So what happened after Markowitz's idea is that three other academics, William Sharp, John Lintner, Fisher Black. Started working on the problem of determining what part of a securities risk can be eliminated by diversification, and what part cannot. And this led to the capital asset pricing model, the main worker's model of finance. So the intuition is very simple, the capital asset pricing model says that there should be no rewards for bearing risks that can be diversified away. Therefore in order to get a higher return, one needs to increase the risk level of a portfolio that cannot be diversified away, right. Which is going to be measured by the beta. So the CAPM says the risk premium of any asset is only determined by its beta. So beta and the CAPM came into high fashion in the early 70s. It was hailed by practitioners and also eventually earned Sharp a Nobel Prize for his contribution to this work that he shared with Markowitz. After hundreds, and hundreds, and hundreds of empirical studies however, we now know that CAPM does not work so well. In fact, in a study published in 1992 Eugene Fama and Ken French divided all traded stocks into 10 groups based on their beta measures. So group 1 contained the 10% of the stocks with the lowest betas. Group 10 contained the 10% of the stocks with the highest betas. And then they looked at the average returns for each group. And what they showed essentially, was that there was no relationship between these, the returns of these 10 portfolios and their beta measures. The relationship they concluded was essentially flat. So by mid 90s, not only the practitioners but also academics thought that the CAPM was pretty much dead. And they went in search of other asset pricing models, and multi factor models began to emerge. So in this final module you're going to learn about the capital enterprising model as well as multi factor models. An example of which will be the Fama–French three-factor model. Now why do we still teach CAPM if we know it doesn't work? Well for one, CAPM is still very widely used and it still provides a very useful framework and insights that help us think about risk. And most importantly, most of the insights developed with CAPM extend to other models as well.