University:
California State University, Los Angeles
Course:
ECON 4030 | Macroeconomics
Academic year:

2023
Views:

119

Pages:

2
Author:

Danial A.

CAPM and The Individual Investor Although CAPM requires that all investors should hold the market portfolio, M, to gain the full benefits of diversification, much of this benefit can be gained from holding far fewer shares. In fact, a portfolio containing only 15-20 randomly selected shares will eliminate around 90 per cent of the shares' unsystematic risk, as Figure shows. In reality many investors do not hold diversified portfolios. This has become particularly true in the UK since the introduction of the government's privatization programme. Many investors hold shares in a single privatization issue. This does not invalidate CAPM; it merely means that investors are accepting some risk for which no reward can be expected. Moreover, in the real world, diversifying a portfolio is not costless. Transaction costs are incurred in buying and selling shares, and these costs are assumed to be absent in CAPM. These costs are not only financial, they also include the effort on the part of an individual in effecting his investment decisions. As the size of the bargain decreases, transaction costs represent an increasing percentage of the value of shares traded. Such costs obviously place a disproportionate burden on small investors. To some extent, these charges can be mitigated for the small investor by investing in assets such as unit trusts, although even here an annual management charge must be paid, in addition to the initial bid/offer spread. Certainly, direct personal share ownership has shown a declining trend in the UK over this century. By value of holding, the private direct investor is now relatively unimportant in the UK market. Most shares are held by financial institutions, such as pension funds and life assurance companies, who are able to trade their shares relatively cheaply. Shares in the UK market are thus generally held by financial institutions, who hold them as part of a well-diversified portfolio.

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