Final Test of Model Depends
- Not on How Reasonable the Assumptions Appear
2. But on How Well Model Describes Reality
Assumptions To Capital- Asset Pricing Model
- No Transaction Cost
- Assets Are Infinitely Divisible
- No Personal Income Tax
- No Individual Investor Can Affect Prices of a Stock by Action of Selling or Buying
- Decisions Solely Based on Expected Return and Risk of Portfolio
- Unlimited Short Sales Are Allowed
- Unlimited Lending and Borrowing At Risk-Less Rate
- & 9. Homogeneity of Expectations
- All Assets Are Marketable
No Transaction Cost
No Cost of Buying or Selling Any Asset
Assets Are Infinitely Divisible
Any Position in an Investment
No Personal Income Tax
Indifferent to the Form in Which Return on the Investment is Received (Dividend or Capital Gains)
No Individual Investor Can Affect Prices of a Stock by Action of Selling or Buying
Investor Cannot Buy in Bulk
Homogeneity of Expectations
- Concerned with the Mean and Variance and Define the Relevant Period in the Same Manner
- Same Expectations With Respect To Inputs to the Portfolio Decisions
Standard CAPM also Called
Sharpe-Lintner-Mossin Form
Efficient Frontier Differs Among Investors
Because of Different Expectations Resulting in Different Selection of Risky Assets
Homogeneity of Expectations
- Means Identical Portfolio of Risky Assets for Each Investor
- In “Equilibrium”, it Leads to Market Portfolio
Market Portfolio
- Demand of a Particular Asset is Same As the Market Value of The Asset
- Hence Proportion of a Particular Asset is fraction of Market Value of That Asset and Total Market Value
Two Mutual Fund Theorem
- Market Portfolio
2. Risk-Less Security
Capital Market Line
Same As Line Connecting Risk- Free and Market Portfolio
All Investors
Hold Efficient Portfolios Along CML
From Equation of CML
- Market Price of Risk
2. Price of Time
Homogeneity of Expectations
- All Investors Hold Same Portfolio
- Sum of Portfolio of All Investors Must Be Same As Tangent Portfolio
- Tangent Portfolio is Same As Market Portfolio
