Selection in incomplete markets and the CAPM portfolio rule

Giulio Bottazzi and Daniele Giachini

LEM Papers Series from Laboratory of Economics and Management (LEM), Sant'Anna School of Advanced Studies, Pisa, Italy

Abstract: 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 assetsù 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.

Keywords: Selection; Evolution; Capital Asset Pricing Model; Incomplete Markets. (search for similar items in EconPapers)
Date: 2020-10-29
New Economics Papers: this item is included in nep-upt
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Citations: View citations in EconPapers (1)

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