Capital market line (CML) reflects the relationship between the excessive return of the portfolio (a simple combination of Market Portfolio and riskfree lending or borrowing) over the riskfree rate, and the TOTAL RISK of that portfolio. That is:
(E(Rx)-Rf)
R(p)=Rf+δp --------------------
δx
Portfoli p – portfolio of the combination of Market Portfolio and riskfree lending or borrowing
Portfolio X – market portfolio, represented by the tangent point of the CML on the efficient frontier.
R(p): return of the portfolio p
Rf: riskfree rate
δp: the standard deviation of portfolio p. It represents the TOTAL RISK of the portfolio p.
E(Rx): the expected return of market portfolio x
δx: the standard deviation of portfolio x.
According to Markowitz portfolio theory, any portfolios below the CML must be inefficient. In another word, investors will not invest in such kinds of portfolios that are dominated by portfolio combinations on the CML. Nevertheless, in the market, we still see some investors holding portfolios that lie below the CML. The reason for this, is that the market will not compensate investors for bearing the TOTAL RISK of portfolios. Instead, the market only compensate investors for bearing the market risk, or so-called systematic risk of portfolios, as it is believed that any specific risk can be diversified away by investors (total risk = systematic risk + specific risk). This results in the existence of the Security Market Line (SML), which depicts the relationship between portfolio’s excessive return over the riskfree rate and the portfolio’s systematic risk – represented by beta. For the Market Portfolio, it has only systematic risk, so the beta of the Market Portfolio is one. Since the Market Portfolio also lies on the SML, that is:
R(p) = Rf + β(Rm – Rf)
R(p): return of the portfolio p
Rf: riskfree rate
Rm: the expected return on the Market Portfolio.
[此贴子已经被作者于2005-5-15 19:04:31编辑过]
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