Question

Suppose we live in a world where CAPM holds true. What is the optimal strategy for an investor who wants to builda portfolio that is riskier than the market?

Answer 1

When we will be living in the theoretical world where Capital Asset pricing model is true, then we will be trying to formulate a Portfolio which will be risky than market by assignment of a higher beta for those shares which are having a higher volatility than the market and we will be trying to apportion extra expected rate of return in adjustment with their volatility to the market.

Capital Asset pricing model assumes that all the unsystematic risk of the portfolio have already been eliminated so investor should be trying to take any combination of stocks and he will already be diversified and he should be trying to calculate the market rate of return and adjusted with risk free rate of return and he will only be having risk in form of systematic risk so he will be adjusting the systematic risk with market risk premium and he will be trying to add it with risk free rate in order to arrive at the expected rate of return so he will always be trying to assign an expected rate of return for the market risk he is exposed to in Capital Asset pricing model so he will be trying to to check the performance of the portfolio in respect to the expected rate of return after the assignment of Beta which is representative of the systematic risk.