Basic asset valuation models In the world of finance, portfolio selection theory plays anessential role, which are models that allow us to choosebetween the different assets on the market, to include themin our own investment portfolio. We can locate the birth ofthe portfolio selection theory with the Markowitz model, which was later developed through the CAPM model(Capital Asset Pricing Model).

 

Below is a table with the main assumptions of both portfolio selection models:

Model Markowitz (1952)	Model CAPM (1961)
The return of an asset is a randomvariable whose distribution is knownto the investor.	All investors act on the basis of theMarkowitz mean and variance model. The return will be explained by itsrelationship with the market risk(Beta).
The risk of a security is measured bythe variance.	There is symmetric information and therefore efficiency in the market.
There is rationality in the behavior ofan investor, where the investor willtry to maximize profitability and minimize risk.	There are no institutional restrictionson investments (short sales, taxes, commissions, etc.)
The difference between the behaviorof investors will be given by theirdifferent degree of risk aversion orpropensity.	There is no influence on the price bya particular investor and thereforethere is perfect competition.

requested:

1. Discuss whether or not it is realistic and why you shouldapply the different assumptions of the Markowitz modelwhen choosing assets for your portfolio.

2. Discuss whether or not it is realistic and why you shouldapply the different assumptions of the CAPM model whenchoosing assets for your portfolio.

3. What are the similarities and differences between bothmodels?