The Theory and Practice of Investment Management: Asset Allocation, Valuation, Portfolio Construction, and Strategies, Second Edition

SHARPE-LINTNER CAPM

The first CAPM was that of Sharpe³⁴ and Lintner.³⁵ The Sharpe-Lintner CAPM (SL-CAPM) assumes the following:

• All investors have the same beliefs concerning security returns.

• All investors have mean-variance efficient portfolios.

• All investors can lend all it has or can borrow all it wants at the same risk-free interest rate that the U.S. federal government pays to borrow money.

By the mean it is meant the expected value of the return of a security or portfolio. Thus, throughout this chapter, we use the terms “mean return” and “expected return” interchangeably. By variance, we mean the variance of the returns of a security or portfolio. This is the square of the standard deviation, the most commonly used measure in statistics to quantify the dispersion of the possible outcomes of some random variable. Standard deviation is the more intuitively meaningful measure: Most of any probability distribution is between its mean minus two standard deviations and mean plus two distributions. It is not true that most of a distribution is between the mean and plus or minus two variances, or any other number of variances. While standard deviation is the more intuitive measure, formulas are more conveniently expressed in terms of variance. One can most easily compute the variance of a portfolio and then take its square root to obtain its standard deviation.

As explained in the previous chapter, by mean-variance efficient portfolios , we mean that of all the possible ...