Haugen’s views• Orthodox financial theory is wrong• Arbitrage does not lead to correct &uniform pricing of risk--APT is false• Investors generally do not useMarkowitz to optimize--CAPM is false• Anomalies rule market pricing• 5 families of risk factors explain returnsHaugen on Beta• Studies find positive returns to beta as theorypredicts• But results of studies collapse if small & largecompanies are analyzed separately• Returns to beta are entirely a small cap effect• Small caps have high beta & high returnsUpshot• Haugen says it is possible to beat themarket with less than average risk• How? Buy value stocks and small caps• Best is small cap value stocks• Value stocks have low beta risk• Small caps deliver excess returnscontrolling for betaYou can do even better• To get even better returns, Haugensuggests subscribing to his ownstatistical model, which he sells• To see Haugen’s pitch, go to his website• Haugen’s model employs 5 families ofrisk factors5 Families of Risk Factors• Market risk factors• Liquidity risk factors• Measures of cheapness• Measures of profitability• Technical factorsMarket Risk factors• market risk• -interest rate spreads• -inflation• -% change in industrial production• -debt/equity• -times interest earned• -earnings volatilityLiquidity Risk Factors• -market cap• -trading volume• -stock priceMeasures of cheapness• Levels & trends in:•-P/E•-P/B•-P/S• -P/dividends• -P/cash flowMeasures of profitability• -ROE• -ROA• -Earnings growth• -capital turnover (Sales/Assets)Technical Factors• -Excess return over S&P index in last 1, 2, 3, 6, 12,24, 60