In: Finance
Briefly discuss Capital Market Theory and how it differs from Markowitz Theory.Briefly discuss Capital Market Theory and how it differs from Markowitz Theory. (500 words include examples)
Capital Market Theory
Capital Market Theory explains relationship between efficient investment returns and associated risk. This relationship is measured by standard deviation. It works mainly on portfolios of risk free assets. Formula of calculation of relationship is as under
Expected return of portfolio = Risk free return + Standard deviation of portfolio * Expected return of market portfolio - risk free return) / standard deviation of market return
Difference between Capital Market Theory and Markowitz Theory i.e. Capital Asset Pricing Model ('CAPM'):-
1. Under Capital Market Theory, risk of assets is measured by standard deviation however under CAPM uses beta coefficient or covariance;
2. Capital Market Theory covers only efficient portfolios however CAPM uses all capital assets and
3. Capital Market Theory determines optimum portfolio of investors however CAPM calculate asset pricing by efficient market in equilibrium.