Microsoft PowerPoint - PoF.ppt

SMLƒ 58

Theorem: If the market is efficient then there exists a perfect linear relation between the beta factors for stocks and their expected rates of return.

The expected rate of return

for a stock is the sum of

ƒ

the risk free rate (compensating fo

r the delay in consumption) and

ƒ

the risk premium for security i (compensating for taking risk):

• risk measure for security i and- market risk premium.

Single-period random cash flows: CAPM

()

( )

[]

(

)

()

M

M i i F M i F i

r

r

r

Cov

where

r r E r r E

2

,

,

σ

β

β

=

−

+

=