Analysis and Investment Recommendations of Capital Asset Pricing Model

Only available on StudyMode
  • Download(s) : 197
  • Published : May 1, 2013
Open Document
Text Preview
1. Analysis and investment recommendation
According to Frino et al (2013), both Mean-Variance and CAPM are based on the assumptions that returns are normally distributed. However, both of the two approaches are unstable and untenable to some extent then they also followed with many critiques and queries from the publicity. Here are some rational and underlying assumptions as follows. 2.1 Rationale and underlying assumptions of MV and CAPM approaches The total risk with a security has two elements. The first element of risk relates to events that affect individual securities alone, this element of risk is commonly referred to as unsystematic (or diversifiable) risk (Frino et al, 2013). This does not influence all securities and can be diversified away. The second element of total risk is related to macroeconomic events that affect the prices of all securities and are reflected in broad market movements (ibid). Under the perfect capital markets, the assumptions for the Mean-Variance approach can be concluded as the following three points: first is the single-period model. Second is the preferences of the investors are merely depend on the mean and variance of payoffs, which means at a given mean, lower variance is preferred and with a given variance, a higher mean is preferred. Last but not least, the price-taking does not include taxes and transaction costs. According to Cousins (n.d.), the CAPM draws conclusions from a variety of assumptions. Some are vital to its premise, others cause only minor changes if they are untrue. Since the early 1970s much research into the plausibility and effects of weakness in these assumptions has been conducted by academia. The assumptions that form the basis for the CAPM are: * Investors in the capital market are risk averse and they always desire more return to less and they will avoid risk if all else is equal. * There are no restrictions on the borrowing and lending of money at the risk-free rate of interest....
tracking img