FNCE30001 Study Guide - Final Guide: Capital Asset Pricing Model, Arbitrage, Invertible Matrix

• School: University of Melbourne
• Department: Finance
• Course: FNCE30001
• Professor: Brown

Document Summary

If investors demand compensation for bearing risk other than that of the market portfolio, then the apt may exist without the capm. Substituting the portfolio returns and betas in the expected return beta relationship, we obtain two equations in the unknowns, the risk-free rate (rf ) and the factor return (f): 14. 0% = rf + 1 (f rf) 14. 8% = rf + 1. 1 (f rf) From the first equation we find that f = 14%. Substituting this value for f into the second equation, we get: 14. 8% = rf + 1. 1 (14% rf) rf = 6% Any pattern of returns can be explained" if we are free to choose an indefinitely large number of explanatory factors. If a theory of asset pricing is to have value, it must explain returns using a reasonably limited number of explanatory variables (i. e. systematic factors).