Beyond CAPM: Limitations and Extensions of CAPM
Limitations of the CAPM Theoretical Limitations of the CAPM Practical Limitations of the CAPM Extensions to the CAPM Theoretical Models Practical Models
Capital Asset Pricing Model: Applications
Estimate of Expected Return
Capital Asset Pricing Model: Assumptions and the Security Market Line
Assumptions of the CAPM The Security Market Line The security market line (SML) is a graphical representation of the capital asset pricing model with beta, reflecting systematic risk, on the x-axis and expected return on the y-axis. Portfolio Beta
Calculation and Interpretation of Beta
beta is a measure of how sensitive an asset’s return is to the market as a whole and is calculated as the covariance of the return on i and the return on the market divided by the variance of the market return; that expression is equivalent to the product of the asset’s correlation with the market with a…
Return Generating Models
A return-generating model is a model that can provide an estimate of the expected return of a security given certain parameters. A multi-factor model allows more than one variable to be considered in estimating returns and can be built using different kinds of factors, such as macroeconomic, fundamental, and statistical factors. Three-Factor and Four-Factor Models The Single-Index Model Decomposition…
Systematic and Nonsystematic Risk
Systematic risk is risk that cannot be avoided and is inherent in the overall market. It is non-diversifiable because it includes risk factors that are innate within the market and affect the market as a whole. Nonsystematic risk is risk that is local or limited to a particular asset or industry that need not affect assets outside…
Capital Market Theory: CML – Leveraged Portfolios
Leveraged Portfolios with Different Lending and Borrowing Rates
Capital Market Theory: The Capital Market Line
Passive and Active Portfolios What Is the “Market”? The Capital Market Line (CML) The capital market line is a special case of the capital allocation line, where the risky portfolio is the market portfolio.
Capital Market Theory: Risk-Free and Risky Assets
Portfolio of Risk-Free and Risky Assets An investor’s portfolio improves if a risk-free asset is added to the mix. In other words, a combination of the risk-free asset and a risky asset can result in a better risk–return trade-off than an investment in only one type of asset because the risk-free asset has zero correlation…