A note on the effects of market inefficiency and portfolio constraints on the relationship between the expected return of an asset and the market

Thomas A. Severini

Economics and Business Letters, 2015, vol. 4, issue 4, 175-182

Abstract: A key assumption of the Capital Asset Pricing Model is that the market portfolio is efficient; when it is inefficient, , the difference between the expected excess return of the asset and the value predicted by the CAPM, is non-zero. In this paper, a simple bound on  is given that depends on the efficiency of the market portfolio. Alternatively, the impact of inefficiency may be viewed in terms of its effect on , the coefficient of the expected market return in the CAPM. A simple bound on the difference between , based on an inefficient market portfolio, and , based on an efficient portfolio, is also given. These results are used to assess the impact of portfolio constraints.

Date: 2015
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