Microsoft PowerPoint - PoF.ppt

CMLƒ 57

In equilibrium returns of the assets have to adjust such that the market portfolio is efficient! How does this happen?

ƒ

The return of an asset depends on

its initial and its final price.

ƒ

All investors do have the same id

eas about the distribution of the

final prices (by assumption).

ƒ

Given some initial prices they so

lve for the best portfolios in a

mean-variance sense.

ƒ

They place orders to acquire their portfolios.

ƒ

Now the market might clear (demand=supply) or not.

ƒ

If it does not clear prices have

to adjust (hence returns change)

and investors have to find

their new optimal portfolio.

ƒ

They place orders again.

ƒ

This procedure is reiterated until the market clears which can only happen when the market portfolio is efficient.

Single-period random cash flows: CAPM