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The Capital Asset Pricing Model as a General Equilibrium with Incomplete Markets

We recast the capital asset pricing model (CAPM) in the broader context of general equilibrium with incomplete markets (GEI). In this setting we give proofs of three properties of CAPM equilibria: they are efficient, asset prices lie on a "security market line," and all agents hold the same two mutual funds. The first property requires a riskless asset, the latter two do not. We show that across all GEI only one of these three properties of equilibrium is generally valid: asset prices depend on covariances, not variances. We extend CAPM to many consumption goods in such a way that all three properties hold. But now the definition of a riskless asset depends on preferences and endowments, and so cannot be specified a priori.

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File URL: http://cowles.econ.yale.edu/P/cd/d09a/d0913.pdf
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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 913.

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Length: 34 pages
Date of creation: May 1989
Date of revision:
Publication status: Published in The Geneva Papers on Risk and Insurance Theory (May 1990), 15(1): 55-71
Handle: RePEc:cwl:cwldpp:913
Note: CFP 759.
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Web page: http://cowles.econ.yale.edu/

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Order Information: Postal: Cowles Foundation, Yale University, Box 208281, New Haven, CT 06520-8281 USA

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  1. Cass, David, 2006. "Competitive equilibrium with incomplete financial markets," Journal of Mathematical Economics, Elsevier, vol. 42(4-5), pages 384-405, August.
  2. Rubinstein, Mark, 1974. "An aggregation theorem for securities markets," Journal of Financial Economics, Elsevier, vol. 1(3), pages 225-244, September.
  3. Bruce C. Greenwald & Joseph E. Stiglitz, 1984. "Pecuniary & Market Mediated Externalities: Towards a General Theory of the Welfare Economics & Economies with Imperfect Information & Incomplete Mrkts," NBER Working Papers 1304, National Bureau of Economic Research, Inc.
  4. Werner, Jan, 1985. "Equilibrium in economies with incomplete financial markets," Journal of Economic Theory, Elsevier, vol. 36(1), pages 110-119, June.
  5. Hart, Oliver D., 1975. "On the optimality of equilibrium when the market structure is incomplete," Journal of Economic Theory, Elsevier, vol. 11(3), pages 418-443, December.
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