Abstract
This paper examines the conditions required to guarantee positive prices in the CAPM. Positive prices imply an upper bound on the equity premium. This upper bound depends on the degree of diversity of firms' fundamentals, and it is independent of investors' preferences. In economies with realistically diverse assets the only positive-price CAPM equilibrium theoretically possible is a degenerate one, with zero equity premium. Furthermore, when specific standard investors' preferences are assumed, the CAPM equilibrium with positive prices may be altogether impossible. A possible solution to these fundamental problems may be offered by the segmented-market version of the model.
| Original language | English |
|---|---|
| Pages (from-to) | 404-415 |
| Number of pages | 12 |
| Journal | Journal of Economic Theory |
| Volume | 137 |
| Issue number | 1 |
| DOIs | |
| State | Published - Nov 2007 |
Bibliographical note
Funding Information:I am grateful to the anonymous referee for his insightful comments and suggestions. Financial support from the Zagagi Fund is thankfully acknowledged.
Keywords
- Capital asset pricing model
- Equity premium
- Positive prices
- Segmented market