What is it about?
The award winning Capital Asset Pricing Model describes the asset allocation of a market in equilibrium. Our contribution is to describe the path taken to reach the equilibrium. We show that mean-variance efficient traders dynamically choose portfolio strategies that force the instantaneous asset-asset correlations towards a saddle point. This saddle point satisfies the fundamental equation of CAPM.
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Why is it important?
Our results provide a theoretical justification for the use of time dependent betas when testing the CAPM equation. More generally though, we mean that it is wrong to use CAPM to estimate the cost of equity (i.e. the expected excess return) from historical betas.
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This page is a summary of: KELLY TRADING AND MARKET EQUILIBRIUM, International Journal of Theoretical and Applied Finance, January 2023, World Scientific Pub Co Pte Lt,
DOI: 10.1142/s0219024923500012.
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