Article1987

The Relation Between Mean-Variance Efficiency and Arbitrage Pricing

157 citations0/0 files storedThe Journal of Business

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Financial Markets and Investment Strategies Stochastic processes and financial applications Economic theories and models

Abstract

The mean-standard deviation diagram has proven to be valuable tool for understanding equilibrium asset-pricing theory. First introduced by Markowitz (1952, 1959) and Tobin (1958), the diagram helps students and researchers alike to develop intuition about the Capital Asset Pricing Model (CAPM). Its properties are useful for analyzing the conditions under which the market portfolio is mean-variance efficient and for linking the location of the market portfolio in the diagram with the validity of the CAPM. In addition, its simple geometry seems to be the critical inspiration for Roll's (1977) argument that the CAPM cannot feasibly be tested because the market portfolio is unobservable and because of a mathematical equivalence between the individual return/'beta' linearity relation and the market portfolio's mean-variance efficiency (p. 129). Recent research on equilibrium asset pricing, both theoretical and empirical, has tended to focus on multibeta pricing models, especially the Arbitrage Pricing Theory (APT). This paper will show that the simple intuition derived from the

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References

1973An Intertemporal Capital Asset Pricing Model 1959Portfolio Selection: Efficient Diversification of Investments 1958Liquidity Preference as Behavior Towards Risk 1972Capital Market Equilibrium with Restricted Borrowing 1977A critique of the asset pricing theory's tests Part I: On past and potential testability of the theory 1972Factor Analysis as a Statistical Method.1980An Empirical Investigation of the Arbitrage Pricing Theory 1972An Analytic Derivation of the Efficient Portfolio Frontier

Cited by

1987On correlations and inferences about mean-variance efficiency 1990Are the Latent Variables in Time-Varying Expected Returns Compensation for Consumption Risk?2005Profitable predictability in the cross section of stock returns 1993The Arbitrage Pricing Theory and Multifactor Models of Asset Returns 1989A Mean-Variance Framework for Tests of Asset Pricing Models 1988An Asset-Pricing Theory Unifying the CAPM and APT

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