The instantaneous capital market line


We show that if the intercept and slope of the instantaneous capital market line are deterministic, then investors will not hold any hedge portfolios in the sense of Merton [9, 11]. They will choose portfolios that plot on the capital market line, and they will slide up and down the capital market line over time as their wealth and risk tolerance change. This result allows us to aggregate over investors and derive a single factor CAPM where the first and second moments of security returns may change stochastically over time and markets are potentially incomplete.

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Correspondence to Lars Tyge Nielsen.

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Received: 21 June 2004, Revised: 10 December 2004,

JEL Classification Numbers:

G11, G12.

An earlier version of this paper was presented at the Econometric Society Meeting in Pasadena (1997) under the title “Portfolio selection and asset pricing with dynamically incomplete markets and time-varying first and second moments”.

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Nielsen, L.T., Vassalou, M. The instantaneous capital market line. Economic Theory 28, 651–664 (2006).

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Keywords and Phrases:

  • Portfolio optimization
  • Incomplete markets
  • Capital market line
  • Mutual fund separation.