Question

Which of the following statements about portfolio theory and asset pricing is most likely to be false? A An arbitrage opportunity arises when the disparity between assets' prices enables investors to construct a zero net investment portfolio that gives a positive net return B The market portfolio lies on the Security Market Line C The greater the variety of assets in a portfolio, the more unsysternatic risk will be diversified away D Similar to the CAPM, the APT requires all investors to be mean-variance optimizers E If a risk-free asset is available, then in theory all investors will choose the same portfolio of risky assets on the Efficient Frontier

Answer 1

The statement suggesting all investors will choose the same portfolio of risky assets on the Efficient Frontier if a risk-free asset is available is the most likely to be false. Investors' varying risk preferences lead to different combinations of risk-free and risky assets in their portfolios.

Step-by-step explanation:

Among the statements about portfolio theory and asset pricing, the most likely to be false is that If a risk-free asset is available, then in theory all investors will choose the same portfolio of risky assets on the Efficient Frontier. This statement is incorrect because it assumes homogeneity among investors' risk preferences. In reality, investors have different levels of risk tolerance and hence, they will select different combinations of the risk-free asset and risky assets to create a portfolio that aligns with their individual risk-return objectives. This mix lies on the Capital Market Line (CML), which differs for each investor based on their risk aversion.

It is true that an arbitrage opportunity allows for a risk-free profit with a zero net investment and that the Security Market Line (SML) includes the market portfolio, which is the aggregate of all assets in the market. Additionally, the more assets there are in a portfolio, the more unsystematic risk can be diversified away, which supports the notion of portfolio diversification. Finally, while both the Capital Asset Pricing Model (CAPM) and the Arbitrage Pricing Theory (APT) seek to explain asset prices, the APT does not necessarily require that all investors are mean-variance optimizers, which is a requirement of the CAPM.