An Economic Analysis of the Competitive Risk-Return Paradigm
AbstractThe traditional CAPM is widely cited as an authoritative foundation for using a positive risk-return relationship in practical applications. Given its wide use, the traditional CAPM is a relevant theoretical context to analyze a competitive asset market’s equilibrium risk-return relationship. An easily understandable Economics market model is used, with substantive detail and sufficient analytical background to get readers up-to-speed, so that its risk-return analysis will be accessible to a broad, multi-disciplined readership. Its negative risk-return conclusion is based on supplementing the CAPM with two assumptions: (1.) The investor population explicitly includes risk-preferring investors (2.) whose trading activity can dominate the asset market. An incomplete information assumption, which would contradict the competitive asset market assumption, is not needed to obtain the negative risk-return result. A universal conclusion that investors are (or should expect to be) rewarded with higher returns for investing in higher risk assets is not supported. This is consistent with Markowitz (2008), who concludes one should not interpret the CAPM’s positive, linear relation between expected beta risk and expected return to indicate “CAPM investors are paid for bearing systematic risk”, and with Sharpe (1991), whose mathematical CAPM equation shows the risk-return relationship, in general, depends on “societal risk tolerance”.
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Bibliographic InfoPaper provided by University of Connecticut, Department of Economics in its series Alumni working papers with number 2013-01.
Length: 41 pages
Date of creation: Jan 2013
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finance; financial economics; capital asset pricing model; capm; asset pricing; investment theory; portfolio theory; theory of portfolio choice; portfolio selection; William sharpe; harry Markowitz; competitive asset market;
Find related papers by JEL classification:
- D4 - Microeconomics - - Market Structure and Pricing
- G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
- M20 - Business Administration and Business Economics; Marketing; Accounting - - Business Economics - - - General
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-06-04 (All new papers)
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