Chapter 09 – The Capital Asset Pricing Model
CHAPTER NINE
THE CAPITAL ASSET PRICING MODEL
CHAPTER OVERVIEW
This chapter presents the capital asset pricing model (CAPM), which is an equilibrium model for the
pricing of assets based upon risk. This model rules out the possibility of arbitrage profits, that is, the
LEARNING OBJECTIVES
After studying this chapter, the student should be able to explain the theory of the capital asset pricing
PRESENTATION OF MATERIAL
9.1 The Capital Asset Pricing Model
The introduction of the CAPM starts with an overview of the importance of the model and the
assumptions that underlie it. The implications or conditions that result from the CAPM are described.
Discussion of the equilibrium conditions that result from the model is very important before the analytical
development of the CAPM.
Chapter 09 – The Capital Asset Pricing Model
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9.2 Assumptions and Extensions of the CAPM
The assumptions used in the equilibrium model are explained using investor expectations. Notably, the
CAPM would predict alpha values of zero for all securities. We find that alphas are not exactly zero as
9.3The CAPM and the Academic World
Testing of the unobservable CAPM market portfolio is targeted at the mean-beta relationship
9.4 The CAPM and the Investment Industry
Despite failing empirical tests, the industry continues to use the single-index CAPM model. Tests over