08 CAPM - The Capital Asset Pricing Model Click to edit...

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Comm367 1 Click to edit Master subtitle style The Capital Asset Pricing Model
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Comm367 2 Equilibrium model that underlies all modern financial theory Derived using principles of diversification with simplified assumptions Markowitz, Sharpe, Lintner and Mossin are researchers credited with its Capital Asset Pricing Model (CAPM)
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Comm367 3 Demand and Supply for Assets u We studied how individual investors (risk-averse and rational) make portfolio selections u If all investors behave the same way, what happens to asset prices? Aggregate demand for a security = sum of individual investors’ demand Supply of a security is assumed to be fixed At equilibrium price, aggregate demand = aggregate supply, for all securities
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Comm367 4 Assumptions u There are many investors, each with a relatively small amount of wealth u Single-period investment horizon u Investments are limited to traded financial assets u The market is perfect No taxes, transaction costs, or restrictions on short selling Information is costless, available to all investors u Investors are rational mean-variance optimizers u All investors analyze securities in the same way and share the same economic view.
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Comm367 5 Efficiency of Market Portfolio u Market portfolio contains all securities and the proportion of each security is its market value as a percentage of total market value u Homogenous expectations t all investors hold the same portfolio of risky assets u At equilibrium, all investors hold the market portfolio Market portfolio is efficient i V V w N i i i i asset of ue market val V where , i 1 = = =
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08 CAPM - The Capital Asset Pricing Model Click to edit...

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