CAPM and Diversification of the Investment Portfolio Under Heterogeneous Volatility

Abstract

The theory of capital (long-term) assets value (Sharpe, 1964, Lintner, 1965, Mossin, 1966), based on G. Markovitz’s model (Markovitz, 1952,1059), has served for many years as the basis for valuations in the investment analysis and corporate finance. However, implicitly, this theory contains an assumption that the financial market exists in a state that is relatively “habitual“ for the investors and is largely homogeneous with regards to the assets risks . Meanwhile, the same theory excludes the possibility of a sudden emergence of destructive elements within the investor portfolios – elements that significantly differ in terms of risks involved from other assets. This may mislead the investors in their investment decision-making. Under certain circumstances the investment portfolio diversification effect may misfire thus leading to a sharp aggravation of risks and, ultimately, to an uncontrollable destabilization of the market. The basic theory is poorly adapted to such changes and, therefore, fails to provide an objective valuation of assets. Meanwhile, technological progress accelerates the processes of capital redistribution between markets and assets. Hence, any sudden destabilizing factor may have an increasing impact and inevitably necessitate certain adjustments in the basic theoretical constructions.