Capm Assumption

Itemize the assumptions of the CAPM model. Describe each assumption in no more than 3 sentences and discuss whether each one is practical in the real world in 1 or 2 sentences

1. The finance market is in perfect competition and Individual investors are price taker and security prices are unaffected by their own trade. However, in practice there exist monopoly and oligopoly in some industries such as the oil industry in China. Sometimes prices are affected by investors.

2. Investor plan for a single-period investment horizon and it ignores everything that might happen after the end of the single- period horizon. However, the reason why people invest is for future consumption, investors' consideration of consumption will affect their investment decision-making .

3. Investors are limited to traded financial assets , including stocks and bonds and to risk-free borrowing or lending arrangement. However, human capitals, private enterprises and governmentally funded assets are not traded. In real life, borrowing rate from bank is always higher than saving rate and 这个怎么说TRADED ASSETS

4. No taxes and no transaction costs on trades in securities. In real life, investors will be charged on taxes and transaction costs and tax implications may different depending on whether the income is from interest, dividends or capital gains. Furthermore, actual trading is costly.

5. All investors are rational mean-variance optimizers, meaning they all use the Markowitz portfolio selection model. Given the same risk, they prefer higher return, given same return, they prefer lower return. In reality, most investors are irrational; their abnormal gains are usually negative and lose money.

6. Information is costless and available to all investors. Investors don't spend on information and there is no asymmetric information between managers in company and investors. However, in real life there always happened the inside trading and investors need to pay for extra information.

7. There are homogeneous expectations. Given a set of security prices and the risk free interest rate, all investors use the same expected returns and covariance matrix of security returns to generate the efficient frontier and the unique optimal risky portfolio. Currently most people think the stock market is bad . In reality, investors will show various expectations for same stock.