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Posted: 2 August 2011 - 0 comment(s) [ Comment ] - 0 trackback(s) [ Trackback ]
Category: Research

The title here is reminiscent of a famous Shakesprearean soliloquy (replace CAPM with Yorick - or google Hamlet), and there are elements of both farce/comedy and also inevitable almost Aristotelean tragedy in the current frenzies in Washington. It could also be "Who stole my Risk Free Rate?"


One spinout is that surely now we can all move away from that old staple of Americo-centric finance, the Capital Asset Pricing Model.


How does it read?


CAPM equation:-                   E(Ri) = Rf + beta(E(Rm)-Rf)
-          E(Ri) is the expected return on the capital asset
-          Rf is the risk-free rate of interest such as interest arising from government bonds
-          beta is the sensitivity of the expected excess asset returns to the expected excess market returns
-          E(Rm) is the expected return of the market


Typically the thinking had always been - start with Rf being the risk free rate, and the "risk-free" security was typically given as that issued by the US government. Then add some country risk for littler, riskier countries, then add some more risk for the share market, with maybe some extra risk added for specific company's shares etc etc.


But the CAPM has all come undone from the centre now, because the notion that the US Goverment's paper has absolute dependability seems to have been totally disproved...






Here is a picture showing the good ole DJIA (circled) with a beta of 1 and the "securities line" in purple.





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