Capital Market Efficiency,
Portfolio Theory and
the Capital Asset Pricing Model
International Financial Markets
Yasmin Shoaib
Capital Market Efficiency,
Portfolio Theory and
the Capital Asset Pricing Model
Agenda
1.
2.
3.
4.
Introduction
Capital Market Efficiency
Portfolio Theory
Capital Asset Pricing Model
4.1
4.2
4.3
4.4
5.
Conclusion
Capital Market Theory
The Capital Market Line
The Security Market Line
Critics on the CAPM
Yasmin Shoaib
Capital Market Efficiency,
Portfolio Theory and
the Capital Asset Pricing Model
Yasmin Shoaib
• Basic concept for understanding of models
• How should an optimal portfolio be combined?
•Which return can be expected of a portfolio, if there is a risk-free
asset?
• Which risk is relevant for a single asset in a portfolio?
1.Introduction
2.Capital Market
Efficiency
3.Portfolio
Theory
4.Capital Asset
Pricing Model
5.Conclusion
Capital Market Efficiency,
Portfolio Theory and
the Capital Asset Pricing Model
Yasmin Shoaib
• basic concept for Portfolio Theory and CAPM
• refers to information processing
• all agents have rational expectations
1.Introduction
2.Capital Market
Efficiency
3.Portfolio
Theory
4.Capital Asset
Pricing Model
5.Conclusion
Capital Market Efficiency,
Portfolio Theory and
the Capital Asset Pricing Model
Yasmin Shoaib
Efficient Markets Hypothesis
(Eugene Fama)
strong
Critics:
semi-strong
Behavioural Finance
weak
1.Introduction
2.Capital Market
Efficiency
3.Portfolio
Theory
4.Capital Asset
Pricing Model
5.Conclusion
Capital Market Efficiency,
Portfolio Theory and
the Capital Asset Pricing Model
Yasmin Shoaib
Dr. Harry
Markowitz
new model for portfolio
selection:
1.Introduction
2.Capital Market
Efficiency
high rate
of return
3.Portfolio
Theory
low risk
4.Capital Asset
Pricing Model
5.Conclusion
Capital Market Efficiency,
Portfolio Theory and
the Capital Asset Pricing Model
deviations of single assets
1.Introduction
2.Capital Market
Efficiency
3.Portfolio
Theory
Yasmin Shoaib
correlation
4.Capital Asset
Pricing Model
5.Conclusion
Capital Market Efficiency,
Portfolio Theory and
the Capital Asset Pricing Model
Yasmin Shoaib
efficient combination:
• same return + less risk
• higher return + same risk
• higher return + less risk
1.Introduction
2.Capital Market
Efficiency
3.Portfolio
Theory
4.Capital Asset
Pricing Model
5.Conclusion
Capital Market Efficiency,
Portfolio Theory and
the Capital Asset Pricing Model
Yasmin Shoaib
Which return, if risk-free asset exists?
Which price/risk for single security?
Capital Market Line
Security Market Line
Capital Market Theory
•homogenous expectations
•information efficiency
•existence of risk-free asset
1.Introduction
2.Capital Market
Efficiency
3.Portfolio
Theory
4.Capital Asset
Pricing Model
5.Conclusion
Capital Market Efficiency,
Portfolio Theory and
the Capital Asset Pricing Model
Yasmin Shoaib
Which return, if risk-free asset exists?
Capital Market Line
1.Introduction
2.Capital Market
Efficiency
3.Portfolio
Theory
4.Capital Asset
Pricing Model
5.Conclusion
Capital Market Efficiency,
Portfolio Theory and
the Capital Asset Pricing Model
Yasmin Shoaib
Which return, if risk-free asset exists?
Capital Market Line
Tobin Separation
(James Tobin)
separation between
finance and
investment decision
1.Introduction
2.Capital Market
Efficiency
3.Portfolio
Theory
4.Capital Asset
Pricing Model
5.Conclusion
Capital Market Efficiency,
Portfolio Theory and
the Capital Asset Pricing Model
Yasmin Shoaib
Which price/risk for single security?
Security Market Line
Which effect on return and risk
of fruitbasket-portfolio, if
amount of apple-asset is
increased?
27 (9/10)
1.Introduction
2.Capital Market
Efficiency
3.Portfolio
Theory
+
4.Capital Asset
Pricing Model
3 (1/10)
5.Conclusion
Capital Market Efficiency,
Portfolio Theory and
the Capital Asset Pricing Model
Yasmin Shoaib
Which price/risk for single security?
Security Market Line
Beta = risk of a single asset
Beta=1
1.Introduction
2.Capital Market
Efficiency
3.Portfolio
Theory
4.Capital Asset
Pricing Model
5.Conclusion
Capital Market Efficiency,
Portfolio Theory and
the Capital Asset Pricing Model
Yasmin Shoaib
Which price/risk for single security?
Security Market Line
Basic Statement of CAPM:
expected rate of return of
risky asset
determined by
risk-free rate of return
+ risk premium
1.Introduction
2.Capital Market
Efficiency
3.Portfolio
Theory
4.Capital Asset
Pricing Model
5.Conclusion
Capital Market Efficiency,
Portfolio Theory and
the Capital Asset Pricing Model
Example:
risk-free rate of return:
Yasmin Shoaib
Which price/risk for single security?
5%
Security Market Line
return on market portfolio: 9%
individual risks: apple:
(beta)
0.7
apple:
0.05 + (0.7 x 0.04) = 0.078
banana: 1
banana: 0.05 + (1 x 0.04) = 0.09
grape:
grape:
1,4
0.05 + (1.4 x 0.04) = 0.106
expected rate on return:
risk-free rate of return + (beta x market risk premium)
1.Introduction
2.Capital Market
Efficiency
3.Portfolio
Theory
4.Capital Asset
Pricing Model
5.Conclusion
Capital Market Efficiency,
Portfolio Theory and
the Capital Asset Pricing Model
Yasmin Shoaib
Critics on the CAPM
• assumptions not realistic
• model not yet verified nor falsified in
analyses
•some effects not explainable by CAPM
1.Introduction
2.Capital Market
Efficiency
3.Portfolio
Theory
4.Capital Asset
Pricing Model
5.Conclusion
Capital Market Efficiency,
Portfolio Theory and
the Capital Asset Pricing Model
Yasmin Shoaib
• Capital asset pricing model builds on Markowitz portfolio
theory and portfolio theory builds on efficient market hypothesis.
• Capital market efficiency refers to information processing.
• Markowitz portfolio theory: optimal portfolio combines assets
with disireable individual risk-return relation and negative
correlations.
• Capital asset pricing model: expected rate of return determined
by risk-free rate of return plus risk premium.
1.Introduction
2.Capital Market
Efficiency
3.Portfolio
Theory
4.Capital Asset
Pricing Model
5.Conclusion
Capital Market Efficiency,
Portfolio Theory and
the Capital Asset Pricing Model
End
Yasmin Shoaib