The assumptions of caPM Investors evaluate portfolios by looking at the expected returns and standard deviations of the portfolios over a one-period horizon. Investors are never satiated, so when given a choice between two otherwise identical portfolios, they will choose the one with the higher expected return Investors are risk-averse, so when given a choice between two otherwise identical portfolios, they wil choose the one with the lower standard deviation
The Assumptions of CAPM • Investors evaluate portfolios by looking at the expected returns and standard deviations of the portfolios over a one-period horizon. • Investors are never satiated, so when given a choice between two otherwise identical portfolios, they will choose the one with the higher expected return. • Investors are risk-averse, so when given a choice between two otherwise identical portfolios,they will choose the one with the lower standard deviation
The assumptions of CAPM Individual assets are infinitely divisible meaning that an investor can by a fraction of a share if he or she so desires There is a riskfree rate at which an investor may either lend or borrow money. Taxes and transaction costs are irrelevant All investors have the same one-period horizon
The Assumptions of CAPM • Individual assets are infinitely divisible, meaning that an investor can by a fraction of a share if he or she so desires. • There is a riskfree rate at which an investor may either lend or borrow money. • Taxes and transaction costs are irrelevant. • All investors have the same one-period horizon
The assumptions of CAPM The riskfree rate is the same for all investors Information is freely and instantly available to all investors Investors have homogeneous expectations, meaning that they have the same perceptions in regard to the expected returns, standard deviation and covariances of securities
The Assumptions of CAPM • The riskfree rate is the same for all investors • Information is freely and instantly available to all investors • Investors have homogeneous expectations, meaning that they have the same perceptions in regard to the expected returns, standard deviation, and covariances of securities
The assumptions of CAPM Implicit means behind the assumptions Efficient market k Everyone has the same information and agrees about the future prospects for assets Perfect market < There are on frictions to impede investing Equilibrium market k Risk-return trade-off
The Assumptions of CAPM • Implicit means behind the assumptions – Efficient Market «Everyone has the same information and agrees about the future prospects for assets – Perfect Market «There are on frictions to impede investing – Equilibrium Market «Risk-return trade-off
The Capital market Line The separation Theorem Everyone would obtain in equilibrium the same tangency. K All investors face the same efficient set Each investor will choose the same com bination of risky securities Each investor will spread his or her funds among risky securities in the same relative proportions
The Capital Market Line • The Separation Theorem – Everyone would obtain in equilibrium the same tangency. «All investors face the same efficient set. – Each investor will choose the same combination of risky securities «Each investor will spread his or her funds among risky securities in the same relative proportions