Question

What joint hypotheses are implied by the CAPM? Why is this important?

Answer 1

The joint hypotheses implied by CAPM and implications related to the same are as follows:

1) Perfect Capital Markets

A perfect capital market would mean that there are zero taxes or transaction costs, information is available freely to all investors, and that all investors are rational and risk averse. The same doesn't hold in the real world scenario since taxes and transaction costs are fundamental to investing. Moreover people needn't always behave rationally which again is a contradicting argument

2) Investors get to borrow at the risk free rate

In the real world, the risk associated with individual investors would in almost all cases be higher than the risk associated with governments. Hence, for an individual investor to borrow at the risk free rate, which is generally the yield at which short term government debt securities are issued, is not possible. This would mean that the actual expected return wouldn't necessarily lie on the SML (Security Market Line) as dictated by CAPM but slightly below it, if one were to just consider the implication of this hypothesis.