Traditional form of capm

The traditional form of the capm is the assumption of the Markowitz model:

1, the investor hopes that the more wealth the better, the utility is a function of wealth, wealth is a function of the rate of return on investment, and therefore it can be assumed that the utility is a function of the rate of return.

2, the investor can know in advance that the probability distribution of the rate of return on investment is normal.

3, investment risk is identified by the variance or standard deviation of the rate of return on investment.

4, the main factors affecting investment decisions for the expected rate of return and risk two.

5, investors are abiding by the principle of dominance (Dominance rule), that is, the same level of risk, choose the higher yield securities; the same level of yield, choose the lower risk securities.

Because the original CAPM model has more defects, it is a static single-period model, and although it is an equilibrium with the participation of investors, it does not reflect the impact of investor behavior on the asset market.

So then the ICAPM was developed, and then the CCAPM, which has a stochastic discount factor form that has been used particularly in empirical evidence and is ideally suited for theoretical research. So although the CCAPM is much later, it is much better.

You can see that this is a very, very general setup, and you can add a lot of other model features to target the impact of a particular change on asset pricing.

Model assumptions:

The CAPM is a very theoretical model that assumes a very simple framework for financial markets, which not only simplifies the analysis, but also expresses the conclusions in a very concise mathematical formula.

The CAPM assumes that all investors in the market are limited in their assessment of risk and return to an analysis of the expected value and standard deviation of the return variable, and that all investors are perfectly rational. Moreover, the market is completely public, all investors have completely equal information and opportunity, and anyone can borrow or lend without restriction at a unique risk-free rate.

As a result, all investors must compute the same optimization problem in making their asset allocations and receive the same efficient frontier and capital market line.