Capital Asset Pricing Compatible with Observed Market Value Weights

  • Author(s): MICHAEL J. BEST, ROBERT R. GRAUER
  • Published: Apr 30, 2012
  • Pages: 85-103
  • DOI: 10.1111/j.1540-6261.1985.tb04938.x

ABSTRACT

We show that the set of expected return vectors, for which an observed portfolio is mean variance (MV) efficient, is a two‐parameter family. We identify ten ways to specify the time series behavior of the two parameters; the result highlights a number of inconsistencies involved in MV modelling. For each of the cases, it permits the inference of the time series of expected return vectors, as well as all the other Capital Asset Pricing Model (CAPM) variables, compatible with a known covariance matrix and the observed time series of market value weights. The empirical work shows that there are substantial case‐to‐case differences in the time series of mean vectors and many of them are quite different from the constant mean vector envisioned in tests of the CAPM.

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