capital market efficiency, portfolio theory and the capital asset pricing model international...

Capital Market Efficiency,Portfolio Theory and

the Capital Asset Pricing Model

International Financial Markets

Yasmin Shoaib


the Capital Asset Pricing Model

Agenda

1. Introduction2. Capital Market Efficiency3. Portfolio Theory4. Capital Asset Pricing Model

4.1 Capital Market Theory4.2 The Capital Market Line4.3 The Security Market Line4.4 Critics on the CAPM

5. Conclusion

Yasmin Shoaib


the Capital Asset Pricing ModelYasmin Shoaib

1.Introduction 4.Capital Asset Pricing Model

2.Capital Market Efficiency

5.Conclusion3.Portfolio Theory

• Basic concept for understanding of models

• How should an optimal portfolio be combined?

•Which return can be expected of a portfolio, if there is a risk-free asset?

• Which risk is relevant for a single asset in a portfolio?






• basic concept for Portfolio Theory and CAPM

• refers to information processing

• all agents have rational expectations






Efficient Markets Hypothesis

(Eugene Fama)

strong

semi-strong

weak

Critics:

Behavioural Finance






new model for portfolio selection:

Dr. Harry Markowitz

high rate of return

low risk






correlation deviations of single assets






efficient combination:

• same return + less risk

• higher return + same risk

• higher return + less risk






Which return, if risk-free asset exists? Which price/risk for single security?

Capital Market Line Security Market Line

Capital Market Theory

•homogenous expectations

•information efficiency

•existence of risk-free asset






Which return, if risk-free asset exists?

Capital Market Line






Which return, if risk-free asset exists?

Capital Market Line

Tobin Separation

(James Tobin)

separation between finance and investment

decision






Which price/risk for single security?

Security Market Line

27 (9/10) + 3 (1/10)

Which effect on return and risk of fruitbasket-portfolio, if amount of apple-asset is

increased?








Beta = risk of a single asset

Beta=1







Security Market LineBasic Statement of CAPM:

expected rate of return of risky asset

determined by

risk-free rate of return

+ risk premium








Example:

risk-free rate of return: 5%

return on market portfolio:9%

individual risks: apple: 0.7

(beta) banana: 1

grape: 1,4

expected rate on return:

risk-free rate of return + (beta x market risk premium)

apple: 0.05 + (0.7 x 0.04) = 0.078

banana: 0.05 + (1 x 0.04) = 0.09

grape: 0.05 + (1.4 x 0.04) = 0.106






Critics on the CAPM

• assumptions not realistic

• model not yet verified nor falsified in analyses

•some effects not explainable by CAPM






• Capital asset pricing model builds on Markowitz portfolio theory and portfolio theory builds on efficient market hypothesis.

• Capital market efficiency refers to information processing.

• Markowitz portfolio theory: optimal portfolio combines assets with disireable individual risk-return relation and negative correlations.

• Capital asset pricing model: expected rate of return determined by risk-free rate of return plus risk premium.



End

capital market efficiency, portfolio theory and the capital asset pricing model international...

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