5. Application to CAPM Flashcards
What portfolio does investors optimally hold according to MPT?
According to MPT investors will optimally hold a mean-variance efficient portfolio
How can you test CAPM holds and what does it mean?
The assumptions of CAPM state that investors are risk averse, that markets are frictionless, that there exist a market portfolio containing all assets, that everyone holds diversified portfolios so that idiosynchratic risk is eliminated.
You test it by:
- Checking if alpha = 0
- All assets lie on SML
What are the implications of different values of beta in CAPM?
Beta = 1 (asset move with market)
Beta > 1 (asset more volatile than market and should give higher return than market)
Beta < 1 (Asset less volatile than market)
Beta = 0 (No correlation to market)
Negative beta (market goes up, stock goes down)
What is Roll’s critique?
The CAPM states that there exists a market portfolio which usually is interpreted as a stock index. Roll’s critique is directed towards the fact that the market portfolio is supposed to include all assets while the stock market does not capture all of that. For instance, there is much wealth allocated in real estate and art which is not included in the stock market.
