Capital Asset Pricing Model, Part Three – Other Assumptions

In Parts One and Two of our examination of the Capital Asset Pricing Model (CAPM), we evaluated two major assumptions:

1) Market returns are properly modeled by a normal distribution

2) Beta (systematic risk) is the sole source of priced risk for an asset or portfolio of asset

As you recall, we found several weaknesses in both assumptions as they may apply to hedge funds. This time, we’ll examine the remaining assumptions underlying CAPM, and see if each is reasonable when applied to hedge fund trading.

CAPM assumes: Continue reading “Capital Asset Pricing Model, Part Three – Other Assumptions” »

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Copyright 2011 Eric Bank, Freelance Writer

18 Jan

Eric Bank Posted in Documenting the Search for Alpha No comments

Capital Asset Pricing Model, Part Two – Systematic Risk

We are reviewing the underlying assumptions made by the Capital Asset Pricing Model (CAPM). Recall from last time the assumption that returns are distributed normally (i.e. a bell-shaped curve) and how this fails to account for skew and fat tails. Today we’ll look at CAPM’s assumption that there is but a single source of priced systematic risk: market beta.