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

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Abstract

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.

Suggested Citation

  • John Geanakoplos & Martin Shubik, 1989. "The Capital Asset Pricing Model as a General Equilibrium with Incomplete Markets," Cowles Foundation Discussion Papers 913, Cowles Foundation for Research in Economics, Yale University.
  • Handle: RePEc:cwl:cwldpp:913
    Note: CFP 759.
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    References listed on IDEAS

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    1. 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.
    2. Werner, Jan, 1985. "Equilibrium in economies with incomplete financial markets," Journal of Economic Theory, Elsevier, vol. 36(1), pages 110-119, June.
    3. Cass, David, 2006. "Competitive equilibrium with incomplete financial markets," Journal of Mathematical Economics, Elsevier, vol. 42(4-5), pages 384-405, August.
    4. Rubinstein, Mark, 1974. "An aggregation theorem for securities markets," Journal of Financial Economics, Elsevier, vol. 1(3), pages 225-244, September.
    5. 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.
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    Cited by:

    1. P. Herings & Felix Kubler, 2007. "Approximate CAPM When Preferences are CRRA," Computational Economics, Springer;Society for Computational Economics, vol. 29(1), pages 13-31, February.
    2. Herings, P.J.J. & Kubler, F., 1999. "The Robustness of the CAPM - A Computational Approach," Discussion Paper 1999-54, Tilburg University, Center for Economic Research.
    3. Csoka, Peter & Herings, P. Jean-Jacques & Koczy, Laszlo A., 2007. "Coherent measures of risk from a general equilibrium perspective," Journal of Banking & Finance, Elsevier, vol. 31(8), pages 2517-2534, August.
    4. John Y. Campbell & Robert J. Shiller, 1996. "A Scorecard for Indexed Government Debt," NBER Chapters,in: NBER Macroeconomics Annual 1996, Volume 11, pages 155-208 National Bureau of Economic Research, Inc.
    5. Gaël Giraud, 2004. "Walrasian non-tâtonnement with incomplete and imperfect markets," Cahiers de la Maison des Sciences Economiques b04119, Université Panthéon-Sorbonne (Paris 1).
    6. Powers, Michael R. & Shubik, Martin, 2001. "Toward a theory of reinsurance and retrocession," Insurance: Mathematics and Economics, Elsevier, vol. 29(2), pages 271-290, October.
    7. John Geanakoplos, 2003. "The Ideal Inflation Indexed Bond and Irving Fisher's Impatience Theory of Interest in an Overlapping Generations World," Cowles Foundation Discussion Papers 1429, Cowles Foundation for Research in Economics, Yale University.
    8. Peter Bossaerts & Charles Plott & William R. Zame, 2005. "Prices and Portfolio Choices in Financial Markets: Theory and Experiments," UCLA Economics Working Papers 840, UCLA Department of Economics.
    9. Shiller, Robert J., 1999. "Social security and institutions for intergenerational, intragenerational, and international risk-sharing," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 50(1), pages 165-204, June.

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