A NOTE ON THE MARKET MODEL AND THE TWO‐PARAMETER MODEL

A NOTE ON THE MARKET MODEL AND THE TWO‐PARAMETER MODEL I. THE TWO-PARAMETER MODEL In the Sharpe-Lintner model, the capital market is assumed to be perfect in the sense that investors are price-takers, and there are no transactions costs, information costs, or taxes. Investors are assumed to behave as if they choose among portfolios on the basis of maximum expected utility. Moreover, given the amount of funds to be invested, the expected utility associated with any portfolio is assumed to be solely a function of the mean and variance of the distribution of the one-period percentage return on the portfolios. This can be shown to imply either that investor utility functions are well approximated by quadratic functions of percentage return or that the joint distribution of the one-period percentage returns on assets is multivariate normal.' The marginal expected utility of expected return is assumed to be positive, and investors are assumed to be risk-averse in the sense-that the marginal expected utility of variance of return is negative. These assumptions imply the efficient set theorem: The optimal portfolio for any investor must be efficient in the sense that no other portfolio with the same or higher expected return has lower variance of return. To get testable implications about the http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Finance Wiley

A NOTE ON THE MARKET MODEL AND THE TWO‐PARAMETER MODEL

The Journal of Finance, Volume 28 (5) – Dec 1, 1973

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Publisher
Wiley
Copyright
1973 The American Finance Association
ISSN
0022-1082
eISSN
1540-6261
DOI
10.1111/j.1540-6261.1973.tb01449.x
Publisher site
See Article on Publisher Site

Abstract

I. THE TWO-PARAMETER MODEL In the Sharpe-Lintner model, the capital market is assumed to be perfect in the sense that investors are price-takers, and there are no transactions costs, information costs, or taxes. Investors are assumed to behave as if they choose among portfolios on the basis of maximum expected utility. Moreover, given the amount of funds to be invested, the expected utility associated with any portfolio is assumed to be solely a function of the mean and variance of the distribution of the one-period percentage return on the portfolios. This can be shown to imply either that investor utility functions are well approximated by quadratic functions of percentage return or that the joint distribution of the one-period percentage returns on assets is multivariate normal.' The marginal expected utility of expected return is assumed to be positive, and investors are assumed to be risk-averse in the sense-that the marginal expected utility of variance of return is negative. These assumptions imply the efficient set theorem: The optimal portfolio for any investor must be efficient in the sense that no other portfolio with the same or higher expected return has lower variance of return. To get testable implications about the

Journal

The Journal of FinanceWiley

Published: Dec 1, 1973

References

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