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CAPITAL ASSET PRICES: A THEORY OF MARKET EQUILIBRIUM UNDER CONDITIONS OF RISK *

CAPITAL ASSET PRICES: A THEORY OF MARKET EQUILIBRIUM UNDER CONDITIONS OF RISK * I. I ntroduction O ne of the problems which has plagued those attempting to predict the behavior of capital markets is the absence of a body of positive microeconomic theory dealing with conditions of risk. Although many useful insights can be obtained from the traditional models of investment under conditions of certainty, the pervasive influence of risk in financial transactions has forced those working in this area to adopt models of price behavior which are little more than assertions. A typical classroom explanation of the determination of capital asset prices, for example, usually begins with a careful and relatively rigorous description of the process through which individual preferences and physical relationships interact to determine an equilibrium pure interest rate. This is generally followed by the assertion that somehow a market risk‐premium is also determined, with the prices of assets adjusting accordingly to account for differences in their risk. A useful representation of the view of the capital market implied in such discussions is illustrated in Figure 1 . In equilibrium, capital asset prices have adjusted so that the investor, if he follows rational procedures (primarily diversification), is able to attain any desired point along a capital market line http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Finance Wiley

CAPITAL ASSET PRICES: A THEORY OF MARKET EQUILIBRIUM UNDER CONDITIONS OF RISK *

The Journal of Finance , Volume 19 (3) – Sep 1, 1964

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References (2)

Publisher
Wiley
Copyright
1964 The American Finance Association
ISSN
0022-1082
eISSN
1540-6261
DOI
10.1111/j.1540-6261.1964.tb02865.x
Publisher site
See Article on Publisher Site

Abstract

I. I ntroduction O ne of the problems which has plagued those attempting to predict the behavior of capital markets is the absence of a body of positive microeconomic theory dealing with conditions of risk. Although many useful insights can be obtained from the traditional models of investment under conditions of certainty, the pervasive influence of risk in financial transactions has forced those working in this area to adopt models of price behavior which are little more than assertions. A typical classroom explanation of the determination of capital asset prices, for example, usually begins with a careful and relatively rigorous description of the process through which individual preferences and physical relationships interact to determine an equilibrium pure interest rate. This is generally followed by the assertion that somehow a market risk‐premium is also determined, with the prices of assets adjusting accordingly to account for differences in their risk. A useful representation of the view of the capital market implied in such discussions is illustrated in Figure 1 . In equilibrium, capital asset prices have adjusted so that the investor, if he follows rational procedures (primarily diversification), is able to attain any desired point along a capital market line

Journal

The Journal of FinanceWiley

Published: Sep 1, 1964

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