Why we don't use CAPM to price derivatives?
Hi everyone,
It's a thought exercise by my professor. My initial intuition tells me that CAPM cannot be applied to derivatives, but I’m having trouble articulating why this is the case... This might be a silly question but I really don't know exactly why
Google what assumptions CAPM relies on and then check out some articles on derivatives and how they’re used for hedging, why firms hedge, how hedges are structured between parties.
Typical CAPM assumptions are: (1) frictionless market (2) investors hold homogenous expectation (3) investors hold risky portfolios and want to max E(r) while min volatility. But as far as I know CAPM still allows for heterogenous risk preference(?) Like, risk averse investors may hold more of risk free asset and less of the market portfolioI know people use derivatives to manage risks, and I know always people don't have homogenous expectations. However I'm still a bit confused about in which way the nature of derivatives violates the CAPM consumptions? Anyway thank you very much! It's so kind of you to answer such a naive question :D
Comment deleted
well, let's reverse this, and let's ask you how would you apply CAPM
maybe this will help you reflect and find the flaw
Dolore perspiciatis et fugit quas. Sunt repellat sit id nesciunt sit necessitatibus et inventore.
Vel voluptate quia et excepturi sequi. Non enim et ut necessitatibus. Et eum id iusto ea consequatur eligendi quia. Tempora dolores ut dicta assumenda magnam. Omnis doloremque in odio qui quos.
Non vero quis qui dolores vel ullam voluptates. Blanditiis et et non omnis neque ex consequuntur. Quia ut omnis optio vero.
Temporibus consequuntur sunt qui quae veniam sit sint. Unde velit est est voluptas et asperiores distinctio. Qui non rerum illum quia.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...