Reference no: EM133115180

Basic asset valuation models

In the world of finance, portfolio selection theory plays an essential role, which are models that allow us to choose between the different assets on the market, to include them in our own investment portfolio. We can locate the birth of the portfolio selection theory with the Markowitz model, which was later developed through the CAPM model (Capital Asset Pricing Model).

Below is a table with the main assumptions of both portfolio selection models:

Model Markowitz (1952)	Model CAPM (1961)
The return of an asset is a random variable whose distribution is known to the investor.	All investors act on the basis of the Markowitz mean and variance model. The return will be explained by its relationship with the market risk (Beta).
The risk of a security is measured byte variance.	There is symmetric information and therefore efficiency in the market.
There is rationality in the behavior ofan investor, where the investor will try to maximize profitability and minimize risk.	There are no institutional restrictions on investments (short sales, taxes, commissions, etc.)
The difference between the behaviors of investors will be given by their different degree of risk aversion or propensity.	There is no influence on the price by a particular investor and therefore there is perfect competition.

It is requested:

1. Discuss whether or not it is realistic and why you should apply the different assumptions of the Markowitz model when choosing assets for your portfolio.

2. Discuss whether or not it is realistic and why you should apply the different assumptions of the CAPM model when choosing assets for your portfolio.

3. What are the similarities and differences between both models?