Capm Derivation
Capm Derivation
Capm Derivation
= .
∂a a=0 σM
= 2 )/σ .
dσ a=0 (σjM − σM
M
E(r̃j ) − rf = βj (E(r̃M ) − rf ),
“the expected excess rate of return on asset j equals its beta times
the expected excess rate of return on the market portfolio.”
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ECON4510 Finance theory Diderik Lund, 8 September 2009
µj = rf + βj (µM − rf ).
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ECON4510 Finance theory Diderik Lund, 8 September 2009
Verbal interpretation:
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ECON4510 Finance theory Diderik Lund, 8 September 2009
Interpretation, contd.
• Observe βM = 1.
• Observe βj = ρjM σj /σM .
• May have σj > σM , and ρjM close to 1.
• Thus possible to have βj > 1 for some assets.
• May also have cov(r̃j , r̃M ) < 0, βj < 0.
• Not very common in practice.
• Such assets contribute to reducing σM (when included in M).
• Valuable to investors. (Question: What does this imply for
value at t = 0? For expected rate of return?)
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ECON4510 Finance theory Diderik Lund, 8 September 2009
Avoid confusion
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ECON4510 Finance theory Diderik Lund, 8 September 2009
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ECON4510 Finance theory Diderik Lund, 8 September 2009
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ph0 = [E(p̃j1 + ε̃) − λ cov(p̃j1 + ε̃, r̃M )]
1 + rf
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= [E(p̃j1) + E(ε̃) − λ[cov(p̃j1, r̃M ) + cov(ε̃, r̃M )]] = pj0.
1 + rf
• At this point: Do not get confused by ρjM .
• Common confusion: Since σjM = ρjM σj σM , some believe that
a higher σj leads to a higher σjM .
• Have just shown a case where this is not true; instead:
σhM σjM σjM
ρhM = = < = ρjM .
σh σM σh σM σj σM
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pi0 = [E(p̃i1) − λ cov(p̃i1, r̃M )]
1 + rf
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= [E(ap̃j1 + bp̃k1) − λ cov(ap̃j1 + bp̃k1, r̃M )]
1 + rf
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= [aE(p̃j1) + bE(p̃k1) − λ[a cov(p̃j1, r̃M ) + b cov(p̃k1, r̃M )]]
1 + rf
= apj0 + bpk0.
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ECON4510 Finance theory Diderik Lund, 8 September 2009
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