Assumptions
Throughout the entire term we will make the following assumptions to simplify our
analysis of asset pricing theory.
1. Securities are traded in frictionless markets. There are no transactions costs
associated with buying or selling securities: commission charges are zero and
"bid prices" always equal "ask prices".
2. Securities are infinitely divisible. For example, an economic agent can
buy/sell 13.458 units of a security that sells for a price of ps, in which case the
total costs/proceeds of the transaction are equal to 13.458 ps.
3. Unless otherwise stated, short sales of securities are permitted. That is, an
economic agent may sell and acquire the proceeds from securities that the agent
does not currently own. As an example, an individual investor can short sell a
Treasury Bill and use the proceeds as he/she sees fit.
4. Unless otherwise stated, there are no taxes.
5. The "No Arbitrage" condition is always satisfied. In other words, there are no
circumstances in which an economic agent can earn a profit with certainty by
simultaneously buying and (short) selling different securities without investing
any of his/her own wealth. This assumption assures that securities markets are in
equilibrium; i.e., at the prevailing price for each security, quantity demanded is
equal to quantity supplied.
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