Investments, tenth edition

Table 9.1

The assumptions 

of the CAPM

1. Individual behavior

a.  Investors are rational, mean-variance optimizers.

b.  Their planning horizon is a single period.

c.  Investors have homogeneous expectations (identical input lists).

2. Market structure

a.  

All assets are publicly held and trade on public exchanges, short positions are allowed, 

and investors can borrow or lend at a common risk-free rate.

b.  All information is publicly available.

c. No taxes.

d.  No transaction costs.

12

 

Michael J. Brennan, “Taxes, Market Valuation, and Corporate Finance Policy,”  

National Tax Journal,

December 1973. 

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  C H A P T E R  

9

  The Capital Asset Pricing Model  

305

there is no decisive evidence that taxes are a major factor in stock returns. A plausible 

explanation for this negative finding relies on “clientele” and supply effects. If high tax-

bracket investors shy away from high-yield (dividend-paying) stocks and thus force down 

their prices, tax-exempt investors will view the stocks as a bargain and take up the slack 

in demand. On the other end, if corporations see that high dividend yields reduce stock 

prices, they simply will substitute stock repurchases for dividends, reinforcing the clientele 

effect in neutralizing tax effects.  

 Finally, transaction costs inhibit trades and thus the reaction to changes in information; 

hence Assumption 2(d) (no transaction costs). While in reality trading costs have fallen, 

remaining differentials in trading costs may still play an important role in stock returns.