What are the assumptions of CAPM?

Answer 1

The assumptions underlying the CAPM's development are as follows, taken fromIntermediate Financial Managementthe Ninth Edition, by Eugene F. Brigham and Phillip R. Davis:

1. All investors focus on a single holding period, and they seek to maximize the expected utility of their terminal wealth by choosing among alternative portfolios on the basis of each portfolio's expected return and standard deviation.

2. All investors can borrow or lend an unlimited amount at a given risk-free rate of interest and there are no restrictions on short sales of any assets.

3. All investors have identical estimated of the expected returns, variances, and covariances among all assets (that is, investors have homogeneous expectations).

4. All assets are perfectly divisible and perfectly liquid (that is, marketable at the going price).

5. There are no transaction costs.

6. There are no taxes.

7. All investors are price takers (that is, all investors assume that their own buying and selling activity will not affect stock prices).

8. The quantities of all assets are given and fixed.