Investors Do Not Get Paid for Bearing Risk

Discussant for Harry Markowitz at the Journal of Investment Management Conference, Fall 2015.

Abstract: The relationship between the excess return of each security and its beta, where beta is defined as its regression against the return on the market portfolio, is linear in the Sharpe–Lintner (“S–L") Capital Asset Pricing Model (“CAPM"). This linear relationship is often interpreted to mean that CAPM investors are paid for bearing systematic risk. In this article, Markowitz will show that this is not a correct interpretation because two securities may have identical risk structures in terms of their covariances with other securities in the market, yet have different excess returns. In fact, if the parameters of the CAPM are generated in a natural way, then securities with the same risk structure almost surely will have different expected returns.

My slides: Download PDF

Markowitz also contributed this idea to Fabozzi's "The Theory and Practice of Investment Management", see Chapter 4 - which in hindsight, I think, does a comprehensive job of clearing up confusion with classical thoughts on CAPM.