Chapter 13 - Elton and Gruber Eighth Edition, Reading 2, Figure 2.3

[Dr. Jayanthi Sankaran]

Hi David,

Was wondering why you did not include Arbitrage Portfolios (Figure 2.3) and Practice Questions in your Study Notes, Q and A's and video tutorials. Is it because past Exams do not reflect this part of Chapter 13? Chapter 13 of the text does have one question on setting up an arbitrage portfolio. I guess we are responsible for them, then.....Just a suggestion

Thanks a tonne!
Jayanthi

 

[Dr. Jayanthi Sankaran]

Hi David,

One more question - is it important to know the CAPM in Price form? In other words, the derivation?

Thanks!

 

[David Harper CFA FRM]

Hi @Jayanthi Sankaran

• That's correct, it's just a choice: this reading is theoretically denser than any historical Part 1 CAPM question. It's interesting because I do write (recently did add) some CAPM-arbitrage type questions, but they were for the Part 2 CAPM assignment (Bodie) where I did take the view that the P2 syllabus suggests a basis for them; i.e., P2 does purport to advance the CAPM from P1 CAPM. I like your suggestion. But, with respect to Part 1, the test of CAPM itself (as opposed to CAPM-based RAPM which is assigned in Amenc) have been consistently focused on the very basics. Not the arbitrage concept; not the derivation; not even the alternative formulations. And, I rather think that would be consistent with a practitioner-oriented exam.
  
• I can't imagine that the derivation itself (of the Price form) is important, unless as a means to reinforce an understanding of the CAPM (of course!). But GARP will never query it, realistically. The final result is useful, I think, but only because it reformats the same idea in price terms. (the second to last formula in particular). But this price form derivation is an example of how this chapter "over-assigns:" it's hard to imagine a practitioner originating any query on this derivation! At most, they might set you up with an alternative formula, like this price form, but such a question would be self-sufficient. It's just my opinion that knowing this derivation is just not important. I hope that's helpful, thanks!

 

[Dr. Jayanthi Sankaran]

Thanks, David - (1) will look into your Bodie notes for the arbitrage portfolio set-up...(2) as far as the price form of CAPM goes, I agree - it is indeed too complicated a derivation from a practitioner perspective! Except for the part on the intuition behind the Certainty Equivalent....