EC3333 Notes03 - Lecture 4 The Capital Asset Pricing Model Capital Asset Pricing Model(CAPM Markowitz Sharpe Lintner and Mossin are researchers

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Lecture 4 The Capital Asset Pricing Model
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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)
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y Individual investors are price takers y Single-period 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 mean-variance optimizers y There are homogeneous expectations Assumptions
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Figure 9.1 The Efficient Frontier and the Capital Market Line
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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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Market Risk Premium y At the aggregate level, borrowing and lending of risk-free 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.

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EC3333 Notes03 - Lecture 4 The Capital Asset Pricing Model Capital Asset Pricing Model(CAPM Markowitz Sharpe Lintner and Mossin are researchers

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