Geometric analysis of the capital asset pricing model

Abstract

The derivation of the capital asset pricing model is in most literature limited to a graphical analysis. Since this method avoids a complicated mathematical framework the derivation is more intuitive to people who are unfamiliar to this topic. This approach, however, can result in misleading or even wrong results if the analysis is imprecise. Some of the main mistakes seem to be already established in financial textbooks. This thesis gives a deeper analysis of the so often used graphical framework used to derive the Capital Asset Pricing Model and indicates some pitfalls. First we present the derivation of a small market containing only few securities before we expand it to one with arbitrary amount of securities.