Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk
William F Sharpe, 1964
The article can be found here
The author is discussing the relationship between an asset's risk and its expected return, and how this relationship can be used to make investment decisions. The author also mentions the concept of the capital market line and how it relates to efficient combinations of assets.
- The capital market line represents the efficient boundary of feasible values of expected return (E) for a combination of assets.
- The relationship between the return of an asset and that of a combination of assets can be shown to be tangent to the capital market line, which leads to a relatively simple formula that relates the expected rate of return to various elements of risk for all assets included in the combination.
- The standard deviation of a combination of assets and a risky asset can be calculated using a specific formula.
- The expected return of a combination of assets can be calculated using another specific formula.
- The relationship between an asset's risk and its expected return can be used to adjust the expected return of assets in a portfolio.
- The prices of assets in a portfolio will change based on the expected return of the portfolio, leading to a revision of prices and a tendency for the investment opportunity curve to become more linear.
- All possibilities in the shaded area can be attained with combinations of risky assets, while points lying along the line PZ can be attained by borrowing or lending at the pure rate plus an investment in some combination of risky assets.
- All combinations involving any risky asset or combination of assets plus the riskless asset must have values of E and OR that lie along a straight line between the points representing the two components.
- The investment plan lying at the point of the original investment opportunity curve where a ray from point P is tangent to the curve will dominate all other possibilities.