General equilibrium models of asset pricing allow us to determine the relevant measure of risk for...

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Finance

General equilibrium models of asset pricing allow us todetermine the relevant measure of risk for any asset and therelationship between expected return and risk.
Two of these models have been subject to fierce debate amongpractitioners and academics, The Capital Asset Pricing Model (CAPM)and The Arbitrage Pricing Model (APT). Based on the assumptions andtests of each model you are asked to:
1. Critically analyse the assumptions of both models.
2. Discuss the similarities and differences between them.
3. If you are a portfolio manager and had to choose one of themodels, which one would you pick up and why?
In the analysis, students are advised to look into issues suchas:
a. The ability of each model to explain systematic risk.
b. Usefulness in predicting excess expected returns.
c. Ability of each model on building up a well-diversifiedportfolio.
d. Main empirical findings related to the models.

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3.8 Ratings (455 Votes)

CAPM According to CAPM there is an equilibrium relationship between risk and return for each security Under the conditions of market equilibrium a security is expected to provide a return commensurate with its unavoidable risk The greater the unavoidable risk of a security the greater the return that investors will expect from the security The relationship between the expected return and unavoidable risk and the valuation of securities is the essence of CAPM Stated in other words the risk averse investors will not hold risky assets unless they are adequately compensated for the risks they bear The following are the important assumptions of the model 1 Investors make their decisions only on the See Answer

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General equilibrium models of asset pricing allow us todetermine the relevant measure of risk for any asset and therelationship between expected return and risk.Two of these models have been subject to fierce debate amongpractitioners and academics, The Capital Asset Pricing Model (CAPM)and The Arbitrage Pricing Model (APT). Based on the assumptions andtests of each model you are asked to:1. Critically analyse the assumptions of both models.2. Discuss the similarities and differences between them.3. If you are a portfolio manager and had to choose one of themodels, which one would you pick up and why?In the analysis, students are advised to look into issues suchas:a. The ability of each model to explain systematic risk.b. Usefulness in predicting excess expected returns.c. Ability of each model on building up a well-diversifiedportfolio.d. Main empirical findings related to the models.