51. Teaching CAPM for a Pre-Finance Graduate Program at the STEM Undergraduate Level: Linear Algebra Perspective
- Author
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Wen-Kuei Chen, Chi-Lu Peng, and An-Pin Wei
- Subjects
Finance ,050208 finance ,capital asset pricing model ,business.industry ,Market portfolio ,General Mathematics ,Yield (finance) ,05 social sciences ,Perspective (graphical) ,Security market line ,Financial engineering ,market portfolio ,0502 economics and business ,Linear algebra ,securities market line ,Computer Science (miscellaneous) ,QA1-939 ,Capital asset pricing model ,050207 economics ,business ,threshold portfolio ,Engineering (miscellaneous) ,benchmark portfolio ,Mathematics ,Universe (mathematics) - Abstract
Students considering a masters in Finance Engineering or Artificial Intelligence in Finance are usually required to have an undergraduate background in science, technology, engineering, or mathematics (STEM). STEM students have a good capacity in mathematics and science, but they may not have studied financial theory. To facilitate the classroom teaching of the Capital Asset Pricing Model (CAPM) for STEM students, this paper seeks to expound on the essence of the theory starting at a two-asset framework. Adopting the concepts proposed by Merton (1972), this paper accomplishes the derivation by virtue of basic mathematical tools such as linear algebra, geometry, and statistics except for calculus. We show that the major aspects of Merton’s derivation of the CAPM for a universe of N assets may also be obtained in a two-asset world. Through the methods of this article, students will learn the in-depth theory of CAPM and its hands-on empirical tool. For example, students will realize that even if investors specify different threshold rewards, their different CAPMs will yield identical pricing for assets and portfolios.
- Published
- 2021