CML, ICAPM/CAPM and APT/IAPT are Inaccurate in Incomplete Markets with Dynamic Un-Aggregated Preferences

Abstract

The CML (Capital Market Line), the Intertemporal-CAPM, the CAPM/SML (Security Market Line) and the Intertemporal Arbitrage Pricing Theory (IAPT) are major elements of modern finance, and are widely used in portfolio management, valuation and capital markets financing. However, these theories are inaccurate and can adversely affect risk management and portfolio management processes. This article contributes to the literature by i) introducing conditions under which ICAPM/CAPM, IAPT and CML may be accurate, and explaining which such conditions are not feasible, ii) introducing a “unified” approach to asset pricing and the conditions under which this approach will work, iii) introducing the Marginal Rate of Intertemporal Substitution among Consumption, Savings, Investment and Production, iv) explaining why the Elasticity of Intertemporal Substitution is insufficient for explaining and analyzing asset pricing and investor preferences, iv) explaining why the existence of incomplete markets and dynamic un-aggregated markets render CML, IAPT and ICAPM inaccurate.