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Chapter 11 Capital Asset Pricing Model (CAPM)
Road Map Part A Introduction to finance. Part B Valuation of assets, given discount rates. Part C Determination of discount rates.

• Historic asset returns. • Time value of money. • Risk. • Portfolio theory. •
Capital Asset Pricing Model (CAPM).

• Arbitrage Pricing Theory (APT).
Part D Introduction to corporate finance.

Main Issues
• Derivations of CAPM • Implications of CAPM • Empirical Evidence

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Capital Asset Pricing Model (CAPM)

Chapter 11

Contents
1 2 3 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . 11-3 The Market Portfolio . . . . . . . . . . . . . . . . . . . . . . 11-4 Derivation of CAPM . . . . . . . . . . . . . . . . . . . . . . 11-5
3.1 3.2 3.3 A Numerical Illustration of CAPM . . . . . . . . . . . . . . . . . 11-6 A Formal Derivation of CAPM . . . . . . . . . . . . . . . . . . . 11-8 Implications of CAPM . . . . . . . . . . . . . . . . . . . . . . . . 11-9

4 5 6 7 8 9

Understanding Risk in CAPM . . . . . . . . . . . . . . . . . 11-12 Applications of CAPM . . . . . . . . . . . . . . . . . . . . . 11-18 Empirical Evaluation of CAPM . . . . . . . . . . . . . . . . . 11-20 Summary of CAPM . . . . . . . . . . . . . . . . . . . . . . . 11-23 Appendix A: Capital Market Line . . . . . . . . . . . . . . . 11-24 Appendix B: Extensions of CAPM . . . . . . . . . . . . . . . 11-25
9.1 9.2 Multifactor CAPM . . . . . . . . . . . . . . . . . . . . . . . . . 11-25 Consumption CAPM (CCAPM) . . . . . . . . . . . . . . . . . . . 11-28

10

Homework . . . . . . . . . . . . . . . . . . . . . . . . . . . 11-31

15.407 Lecture Notes

Fall 2003

c Jiang Wang

Chapter 11

Capital Asset Pricing Model (CAPM)

11-3

1

Introduction

Portfolio theory analyzes investors’ asset demand given asset returns. This chapter studies how investors’ asset demand determines the relation between assets’ risk and return in a market equilibrium (when demand equals supply). A... [continues]

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