Hi,when I read investment books I see them covering efficient frontier then jumping to CAPM. the link between the two is still unclear to me although I know that diversification eliminayes the unsystematic and leave the systematic. Should we invest according to our utility functions and the CML line (max - mean variance returns) or according to the SML line (i.e form a portfolio based on the systematic risk?)Thx

In the Capm you are using one more security: the risk free one, while Markowitz is based only on risky assets.Moreover, because of the fact that the market in paying only the systematic risk (the unsystematic one can almost be eliminated by diversification), in order to invest you should use your utility function and the SML.Hope it may helpRegards

when you use the risk free security you are on the Capital market line (CML) line which is the relationship between variance and expected return. the tangent portfolio is the market portfolio , which means you are holding only two assets (the riskty market portfolio and the risk free asset: the separation theorem). why do we study that we can move to the right hand of the portfolio and to the left hand side of teh portfolio by lending if our decisions are based on systematic risk.? this is what confusing me. I find this information completely unnecessary if we use CAPM to make decisisons.

QuoteOriginally posted by: JosephFrankwhy do we study that we can move to the right hand of the portfolio and to the left hand side of teh portfolio by lending if our decisions are based on systematic risk.? this is what confusing me. I find this information completely unnecessary if we use CAPM to make decisisons.That was my same question and I found a naive way to answer.I think that it is the same when we are moving from the historical probability to the risk neutral one in option pricing.In the SML you are analizing the beta of the share, which is not considering the unsystematic risk (like pricing an option unxder the risk neutral probability), while in the CML you are considering also the unsystematic risk (like pricing an option with historical probability).Moreover CML only tells you the fact that if you pass the tangent portfolio it means that are going to invest all your borrowed money in your tangent portfolio.It is like you have a negative weight invested in the risk free asset.Regards