Austrian Economics and the Capital Asset Pricing Model: A Reconcilation?
The capital asset pricing model (CAPM) is an important investment model that describes how investors expect to be compensated for the time value of money and risk. The more risk you take, the more you want to be compensated. The formula is expressed as follows:
(A) Re = Rf Beta * (Rm – Rf),
where Rf is risk-free return, Rm is the market return, and Beta is a risk element.
A pure risk-free rate of return does not exist. Any government could print money and “safely” return money. However, in that case, you probably get money with less purchasing power back. For that purchasing loss, a lender wants to be compensated.
In Human Action, Ludwig von Mises explains that an investor’s required return (Rr) consists of the originary interest rate (Ro), a compensation for the risk (Rrisk), and a compensation for an expected increase in the price level (Pe). The formula is as follows:
(B) Rr = Ro Rrisk Pe.
This required return applies to equities as well as bonds. Because equities are riskier than bonds, equities will have a higher risk premium.
Murray N. Rothbard explains that the production structure is an essential part of the time market. The originary interest rate, as determined in the time market, is reflected in the production structure’s slope. The actual slope and actual investment return is the ratio of the future selling price (future revenue) compared to the current buying price (current costs).
In this article, I explain why formula B is relevant for investors and in discussing impact investing.
People are living in a society because together we can achieve more than on our own. The benefits of living and working together are what I call soci
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