Chapter 9
Capital asset pricing model is a set of predictions concerning equilibrium expected returns
on risky assets.
CAPM is based on 2 sets of assumptions:
Based on 2 assumptions. 1. Pertains to investor behaviour and allowa us to assume investors
are alike + they are all mean variance optimisers with common time horizon and common
set of info reflected in use of identical input list. 2. Pertains to market setting, asserting well
functioning market with few impediments to trading.
Suppose all investors optimise their portfolio using Markowitz model of efficient
diversification – each investor uses input list to draw eddicient frontier of all available risky
assets and identifies an efficient risku portfolio by drawing tangent ( CAL ) to frontier. // eacj
investor holds securities in investable universe with weights by Markowitz optimisation
process.
CAPM asks what happens if all investors shared identical investable universe and used same
input list to draw efficient frontiers.
Market portfolio
Market portfolio is aggregation of all investors risky portfolio, so it has same weights since
they are all identical
Proportion of each stock in portfolio = market value of stocks divided by sum of market value
of all stocks.
CAL is based on each investors optimal risky portfolio is also capital market line.
CML is CAL constructed from money market and market portfolio
Passive Strategy
Capital asset pricing model is a set of predictions concerning equilibrium expected returns
on risky assets.
CAPM is based on 2 sets of assumptions:
Based on 2 assumptions. 1. Pertains to investor behaviour and allowa us to assume investors
are alike + they are all mean variance optimisers with common time horizon and common
set of info reflected in use of identical input list. 2. Pertains to market setting, asserting well
functioning market with few impediments to trading.
Suppose all investors optimise their portfolio using Markowitz model of efficient
diversification – each investor uses input list to draw eddicient frontier of all available risky
assets and identifies an efficient risku portfolio by drawing tangent ( CAL ) to frontier. // eacj
investor holds securities in investable universe with weights by Markowitz optimisation
process.
CAPM asks what happens if all investors shared identical investable universe and used same
input list to draw efficient frontiers.
Market portfolio
Market portfolio is aggregation of all investors risky portfolio, so it has same weights since
they are all identical
Proportion of each stock in portfolio = market value of stocks divided by sum of market value
of all stocks.
CAL is based on each investors optimal risky portfolio is also capital market line.
CML is CAL constructed from money market and market portfolio
Passive Strategy
