Would the CAPM Hold in a Risk-Indifferent World?
AbstractThe Relative Value Theory predicts equilibrium prices in a world in which time value of money is unique, and investors are risk-indifferent and only care about maximizing cumulative returns. This paper shows that RVT’s equilibrium prices determine intrinsic expected returns that satisfy the CAPM equation. The intrinsic return of the risk-free asset is equal to the harmonic mean of the market’s intrinsic returns (intrinsic returns are returns from equilibrium price to underlying intrinsic values). Asset specific betas can be explained by simply assuming scenario probabilities fluctuate in time. Market price return betas are approximately equal to intrinsic return betas. Market price expected returns do not satisfy the CAPM equation but will appear linear in the market premium, with the risk-free rate as intercept. The above results significantly strengthen RVT’s ability to explain market prices’ behavior. Recasting most finance theory results into an RVT framework appears possible and beneficial.
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Bibliographic InfoPaper provided by EconWPA in its series Finance with number 0402020.
Date of creation: 27 Feb 2004
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Relative Value Theory; CAPM; RVT; Asset Valuation; Market Equilibrium; Beta; Rationality;
Find related papers by JEL classification:
- G - Financial Economics
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-02-29 (All new papers)
- NEP-CFN-2004-02-29 (Corporate Finance)
- NEP-FIN-2004-02-29 (Finance)
- NEP-FMK-2004-02-29 (Financial Markets)
- NEP-RMG-2004-02-29 (Risk Management)
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