The Capital Asset Pricing Model as a General Equilibrium With Incomplete Markets*
We recast the capital asset pricing model (CAPM) in the broader context of general equilibrium with incomplete markets (GEI). In this setting we give proofs of three properties of CAPM equilibria: they are efficient, asset prices lie on a â€œsecurity market lineâ€, and all agents hold the same two mutual funds. The first property requires a riskless asset, the latter two do not. We show that across all GEI only one of these three properties of equilibrium is generally valid: asset prices depend on covariances, not variances. We extend CAPM to many consumption goods in such a way that all three properties hold. But now the definition of a riskless asset depends on preferences and endowments, and so cannot be specified a priori. The Geneva Papers on Risk and Insurance Theory (1990) 15, 55â€“71. doi:10.1007/BF01498460
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