Question

Explain graphically and verbally the connection from the Markowitz model to the Capital Asset Pricing Model (CAPM).

Answer 1

Markowitz model: -

Explain the benefits of diversification i.e; when we combine stock in the portfolio then risk of portfolio get reduced due to correlation between them. The extent of diversification of portfolio get risk reduced depends upon correlation. Lower correlation------ no benefit, negative correlation----- get benefit.

CAPM:-

Believes that more diversication, cancelled off unsystemmatic risk and remains systematic risk which is not diversifiable according to CAPM model.

Hence markowitz model talks about total risk reduction while CAPM focus on only systematic risk i.e. market risk.