Investments

CHAPTER 9
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The Capital Asset

Pricing Model
Slides by
Richard D. Johnson
McGraw-Hill/Irwin

Copyright 2008 by The McGraw-Hill Companies, Inc. All rights reserved

Capital Asset Pricing Model

(CAPM)

It is the equilibrium model that

underlies all modern financial theory.
Derived using principles of
diversification with simplified
assumptions.
Markowitz, Sharpe, Lintner and Mossin
are researchers credited with its
development.
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Assumptions
Individual investors are price takers.
Single-period investment horizon.
Investments are limited to traded
financial assets.
No taxes and transaction costs.

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Assumptions (contd)
Information is costless and available
to all investors.
Investors are rational mean-variance
optimizers.
There are homogeneous
expectations.

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Resulting Equilibrium
Conditions
All investors will hold the same
portfolio for risky assets market
portfolio.
Market portfolio contains all
securities and the proportion of each
security is its market value as a
percentage of total market value.

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Resulting Equilibrium
Conditions (contd)
Risk premium on the the market
depends on the average risk aversion
of all market participants.
Risk premium on an individual
security is a function of its
covariance with the market.

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Figure 9.1 The Efficient Frontier and the

Capital Market Line

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Slope and Market Risk

Premium
M=Market portfolio
rf=Risk free rate
E(rM) - rf=Market risk premium
E(rM) - rf=Market price of risk

M
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=Slope of the CAPM

Return and Risk For Individual

Securities
The risk premium on individual
securities is a function of the
individual securitys contribution to
the risk of the market portfolio.
An individual securitys risk premium
is a function of the covariance of
returns with the assets that make up
the market portfolio.

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Figure 9.2 The Security

Market Line

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Figure 9.3 The SML and a Positive-Alpha

Stock

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Figure 9.4 Frequency Distribution of Alphas

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The CAPM and Reality

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Is the condition of zero alphas for all stocks as implied by the

CAPM met?
Not perfect but one of the best available
Is the CAPM testable?
Proxies must be used for the market portfolio
CAPM is still considered the best available description of security
pricing and is widely accepted
Adalah kondisi nol Alpha untuk semua saham seperti yang tersirat
oleh CAPM bertemu?
Tidak sempurna tapi salah satu yang terbaik yang tersedia
Adalah CAPM diuji?
Proxy harus digunakan untuk portofolio pasar
CAPM masih dianggap deskripsi terbaik yang tersedia dari harga
keamanan dan diterima secara luas

Extensions of the CAPM

Zero-Beta Model
Helps to explain positive alphas on low beta stocks and
negative alphas on high beta stocks

Consideration of labor income and non-traded assets

Mertons Multiperiod Model and hedge portfolios
Incorporation of the effects of changes in the real rate of
interest and inflation
Model nol-Beta
Membantu menjelaskan Alpha positif pada saham beta
rendah dan Alpha negatif pada saham beta tinggi
Pertimbangan pendapatan tenaga kerja dan aset nonbelikan
Merton multiperiod Model dan hedge portofolio
Penggabungan efek perubahan dalam tingkat suku
bunga riil dan inflasi
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CAPM & Liquidity

Liquidity
Illiquidity Premium
Research supports a premium for illiquidity.
Amihud and Mendelson
Acharya and Pedersen
Likuiditas
likuiditas Premium
Penelitian mendukung premi untuk likuiditas.
Amihud dan Mendelson
Acharya dan Pedersen
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Figure 9.5 The Relationship Between

Illiquidity and Average Returns

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