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Multi-Period Capital Asset Pricing Models

  • CAPM assumes that investors make their investment decisions at one point in time
  • However in reality, the investment decisions are spread over the lifetime of the investor
  • Many assumptions that are true for single period CAPM are also good for evaluating CAPM in multi period environment
  • Since the investor’s utility change over the period of time, so it is good examine multi period capital asset pricing model
  • Three versions are:
    • Consumption oriented CAPM
    • CAPM including inflation
    • Multi-beta CAPM

Consumption Oriented CAPM

Assumptions of consumptions oriented CAPM are:

  • Investors maximize multi-period utility function for consumption over the lifetime.
  • Investors have homogenous expectations regarding return characteristics.
  • The number of investors are fixed
  • There is a single consumption good
  • There is a capital market to allow investors to reach a consumption pattern that they cannot afford by additional trades
  • Growth of per capita consumption replaces the market portfolio’s return as a factor affecting the equilibrium returns

CAPM including Inflation

  • CAPM including inflation looks similar to the CAPM in simple form
  • Market risk is greater than as predicted by CAPM if correlation between return and inflation
  • is positive
  • Asset Risk is also a function of its covariance with inflation rate

Multi-Beta CAPM

  • Multi Beta CAPM assumes that the returns from the security are dependent on multiple factors
  • New terms are added to standard CAPM, which are the product of new beta or sensitivity to the new risk factor and the price of that risk factor
  • Multiple risk factors such as inflation risk, future labour income, prices of consumable goods etc.

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