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Multifactor Portfolio Efficiency and Multifactor Asset Pricing

Eugene F. Fama
The Journal of Financial and Quantitative Analysis
Vol. 31, No. 4 (Dec., 1996), pp. 441-465
DOI: 10.2307/2331355
Stable URL: http://www.jstor.org/stable/2331355
Page Count: 25
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Multifactor Portfolio Efficiency and Multifactor Asset Pricing
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Abstract

The concept of multifactor portfolio efficiency plays a role in Merton's intertemporal CAPM (the ICAPM), like that of mean-variance efficiency in the Sharpe-Lintner CAPM. In the CAPM, the relation between the expected return on a security and its risk is just the condition on security weights that holds in any mean-variance-efficient portfolio, applied to the market portfolio M. The risk-return relation of the ICAPM is likewise just the application to M of the condition on security weights that produces ICAPM multifactor-efficient portfolios. The main testable implication of the CAPM is that equilibrium security prices require that M is mean-variance-efficient. The main testable implication of the ICAPM is that securities must be priced so that M is multifactor-efficient. As in the CAPM, building the ICAPM on multifactor efficiency exposes its simplicity and allows easy economic insights.

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