Published online by Cambridge University Press: 06 April 2009
In many circles the Mean Variance Capital Asset Pricing Model (MV CAPM) is synonymous with the theory of capital asset pricing. But in a single-period discrete-time model which explicitly recognizes the existence of limited liability the derivation of the MV CAPM, if it is to be consistent with the von Neumann-Morgenstern postulates of rational behavior, must be based on the assumption that all investors have quadratic utility functions. This assumption in turn implies that risky assets are inferior goods. However, if we turn to the broader class of linear risk tolerance (LRT) utility functions, for which the separation property holds, other simple two-mutual-fund CAPMs can be derived. The power utility LRT CAPMs are of particular interest as they are consistent with risky assets being normal goods.
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