Selection in incomplete markets and the CAPM portfolio rule

Arbeitspapier

This paper studies whether, and to what extent, trading in an incomplete competitive market rewards the CAPM portfolio rule over alternative rules. We find that, if a mean-variance trader faces an agent who invests in each asset proportionally to expected relative payoffs, in the long-run only two scenarios are possible: either the mean-variance trader vanishes or both agents survive with fixed and constant wealth shares. In both cases, asymptotic prices are proportional to assets' expected payoff, and the relation between prices and returns implied by the CAPM does not generally hold. Conversely, when a mean-variance trader faces a generic fixed-mix investor, several long-run outcomes are possible, such as dominance of one trader, survival of both, and generic path-dependency. We provide sufficient conditions to assess such outcomes. We find that the different outcomes can be effectively discussed in terms of the effective risk aversion of the trading strategies, as implied by their portfolio choices conditional on prevailing market prices. In general, a larger effective risk aversion constitutes a survival advantage.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: LEM Working Paper Series ; No. 2020/29

Classification and Topics

• Classification: Wirtschaft ; Mathematical Methods; Programming Models; Mathematical and Simulation Modeling: General ; General Equilibrium and Disequilibrium: Financial Markets ; Asset Pricing; Trading Volume; Bond Interest Rates ; Information and Market Efficiency; Event Studies; Insider Trading
• Subject: Selection ; Evolution ; Capital Asset Pricing Model ; Incomplete Markets

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Bottazzi, Giulio ; Giachini, Daniele
• Event: Veröffentlichung
• (who): Scuola Superiore Sant'Anna, Laboratory of Economics and Management (LEM)
• (where): Pisa
• (when): 2020

Further information

• Handle: http://hdl.handle.net/10419/243487
• Last update: 10.03.2025, 11:46 AM CET