The approach we will take is to ask; if everyone in the economy holds an efficient portfolio then how should securities be priced so that they are actually bought 100% in equilibrium? For example if based on the prices/ expected returns our model comes up with, we found that IBM would never enter any maximizing investor's portfolio(long), then something is wrong IBM would be priced too high(offer too low an expected rate of return) The price of IBM would have to fall to the point where in aggregate, investors want to hold exactly the number of IBM shares outstanding Similarly, if we found that every one of a million optimizing investors would want to purchase $1M worth of Intel, and there are only $1B worth of Intel shares, our model's price for Intel must be too low So, what sort of prices(risk return relationships are feasible in equilibrium? This is the question we will try to answer with the CAPM◼ The approach we will take is to ask: if everyone in the economy holds an efficient portfolio, then how should securities be priced so that they are actually bought 100% in equilibrium? ◼ For example, if based on the prices/expected returns our model comes up with, we found that IBM would never enter any maximizing investor's portfolio (long), then something is wrong. ◼ IBM would be priced too high (offer too low an expected rate of return). ◼ The price of IBM would have to fall to the point where, in aggregate, investors want to hold exactly the number of IBM shares outstanding. ◼ Similarly, if we found that every one of a million optimizing investors would want to purchase $1M worth of Intel, and there are only $1B worth of Intel shares, our model's price for Intel must be too low. ◼ So, what sort of prices (risk/return relationships) are feasible in equilibrium? This is the question we will try to answer with the CAPM