Question

14. a. List reasons that an international extension of the CAPM is problemati. b. In an international extension of the CAPM, why would the optimal portfolio differ from the world market portfolio, as suggested by the traditional CAPM, even if the markets are fully efficient?

Answer 1

Answers:

1. A) Reasons that an international extension of CAPM is problematic:

             The derivation of the traditional CAPM relies on assumptions about investors’ expectations and market perfection. In the international context, tax differentials, high transaction costs, regulations, capital, and exchange controls are obvious market imperfections. Their magnitude is greater than in a domestic context and is more likely to create problems in the model.

b) Differences between optimal portfolio & world market portfolio:

Because of deviations from purchasing power parity (real exchange rate movements), investors from different countries have a different measure of the real return of a given asset. For example, if the euro depreciates by 20 percent, a U.S. investor may obtain a negative (real dollar) return on his Club Med investment, while a French investor could obtain a positive (real Euro) return on Club Med.