Expectations Variance And CAPM

Expectations variance trade off

The attitude of investors to expectations and variance of returns integrates extensively with their attitude toward the wait until those returns are realized. People clearly prefer more return over less return. People similarly prefer more certain return over less certain return and finally people prefer early return over later return. The complexity of expectations variance analysis grows extensively with larger portfolios.

The capital asset pricing model

In the early days of expectations variance analysis, computational capabilities limited the potential for worthy analysis. Despite the enhanced systems of today, problems remain with this approach. Notably, collecting and interpreting the myriad of data associated with large numbers of securities makes the analysis awkward at best. One of the first techniques devised to simplify the analysis of portfolios was to identify and use relevant indices. The capital asset pricing model (CAPM) emerged as the widespread technique employed in portfolio design. A number of researchers contributed to the development of the CAPM and its application. Among them were William Sharpe, James Tobin.

Sample CAPM problems