Chap009_CAPM - Investment Analysis and Portfolio Management...

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Investment Analysis and Portfolio Management The Capital Asset Pricing Model (CAPM) 26/03/13 1
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Main Points CAPM: Capital Asset Pricing Model CAPM, a general equilibrium model CAPM provides us an equation that: Predicts the equilibrium expected return on risky assets , Defines Beta, the relevant risk Indicates which portfolios should investors hold in equilibrium? Sharpe, Lintner and Mossin are researchers credited with its development. William Sharpe won the Nobel Prize in 1990. 26/03/13 2
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CAPM Assumptions Derived using Markowitz’s principles of portfolio theory, with additional simplifying assumptions: 1. Individual investors are price takers 2. Single-period investment horizon Ensures that every investor has the same investment problem. 1. Investments limited to publicly traded financial assets 2. Investors pay no taxes on return and no transaction costs on trades 3. Information is costless and available to all investors 4. Investors are rational mean-variance optimizers 5. Homogeneous expectations 26/03/13 3
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Market Equilibrium Asset prices are results of trading interactions between individuals. In economics, when everyone in the market is content with her holdings and not going to do something differently, the market is in equilibrium. When the market is in equilibrium, stock prices are stable. 26/03/13 4
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All investors will hold the same portfolio for risky assets – market portfolio.
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