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Lecture 4
The Capital Asset Pricing
Model
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View Full Document y
Markowitz, Sharpe, Lintner and Mossin are
researchers credited with its development
y
The equilibrium model that underlies all
modern financial theory
y
Derived using principles of diversification
y
Based on simplified assumptions
Capital Asset Pricing Model (CAPM)
y
Individual investors are price takers
y
Singleperiod investment horizon
y
Investments are limited to traded financial assets
y
No taxes and transaction costs
y
Information is costless and available to all
investors
y
Investors are rational meanvariance optimizers
y
There are homogeneous expectations
Assumptions
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View Full Document Figure 9.1 The Efficient Frontier and the Capital
Market Line
Optimal Risky Portfolio
y
All investors use identical Markowitz analysis
applied to the same universe of securities for the
same time horizon and use the same input list
(homogenous beliefs)
y
Arrive at the same composition of optimal risky
portfolio
y
Every security must be included due to the price
adjust process
y
Thus this portfolio cannot be different from the
market portfolio
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View Full Document Market Risk Premium
y
At the aggregate level,
borrowing and lending of
riskfree asset canceled out with each other
y
The representative investor holds 100% of risky
portfolio
y
Recall
2
)
(
*
p
A
r
p
r
E
p
f
y
σ
−
=
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This note was uploaded on 10/30/2011 for the course ECON EC3333 taught by Professor Lu during the Spring '11 term at National University of Singapore.
 Spring '11
 Lu
 Economics

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