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IAI Actuarial Core Principles · Economic Modelling · Capital Asset Pricing Model (CAPM)

Which of the following is an assumption of the single-period CAPM as usually stated?

The correct assumption is that investors can borrow and lend any amount at one risk-free rate. CAPM also assumes homogeneous expectations, no taxes or transaction costs, and mean-variance preferences, so the other options contradict the model.

  1. AInvestors can borrow and lend unlimited amounts at a single risk-free rateCorrect
  2. BInvestors have different beliefs about expected returns and covariances
  3. CTransaction costs and taxes affect the optimal portfolios
  4. DAsset returns follow a non-normal distribution with skewness
  5. Investors hold portfolios to maximise expected terminal wealth ignoring risk

Explanation

The CAPM assumes investors are mean-variance optimisers with homogeneous expectations, no taxes or transaction costs, and unlimited borrowing and lending at the risk-free rate. The other options contradict these assumptions, for example homogeneous expectations are required, not differing beliefs.

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