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Capital Asset – Definition

Capital Asset Definition

A capital asset refers to a particular capital element, could be of equipment or production, used in the production of another good and eventually becomes part of a company capital. Unlike consumer goods, capital assets are not directly consumed by customers.

A Little More on What is a Capital Asset

In a capital system, capital goods entail accumulated capital that can be used to produce more goods. As such, they are classified into a group known as “physical capital.”

There is a distinctive difference between capital goods and intermediate goods although they are both form part of the production process. They have different dictation and consumption patterns; while capital assets have longer duration and are dependent on their own useful life, intermediate goods have shorter production process and are more dependent on the production cycles. Intermediate goods are also known to transform into consumer goods during the production process.

Capital goods production has traditionally been an indicator of economic development. It shows the ability of a country to be able to own its technology for manufactured goods production. This process not only aids in the generation of large volumes of investment and employment, but also results in the development of a stronger financial economy to support the activities and other auxiliary services. Thus, capital goods are considered a pillar of the productive system by most countries.

References for Capital Assets

Academic Research on Capital Asset

  • Capital asset prices: A theory of market equilibrium under conditions of risk, Sharpe, W. F. (1964). The journal of finance, 19(3), 425-442. This article analyses the effectiveness of traditional investment models to assess the behavior of capital markets. According to the author, although useful insights can be obtained from the traditional models, the pervasive influence of financial transaction risk has made several management teams to adopt price behavior models that are a little more than assertions. The author utilizes a graph to illustrate the views of the capital market as influenced by the traditional investment models. Furthermore, new concepts such as ‘capital market line’ and ‘price of time’ are explained in regard to capital asset market prices.
  • The arbitrage theory of capital asset pricing, Ross, S. A. (2013). In HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING: Part I (pp. 11-30). This study explores the capital asset pricing arbitrage model which was developed by Ross. The model had been proposed as an alternative to the pricing model of variance capital invented by Sharpe, Treynor, and Lintner which is currently used to assess the capital market phenomena. According to the authors, the principles of the mean variance model assets that for every asset, i, its expected return where ρ is the riskless rate of interest, is the expected excess return on the market, E −ρ, and is the beta coefficient on the market, where σ is the variance of the market portfolio and is the covariance between the returns on the ith asset and the market portfolio…
  • Equilibrium in a capital asset market, Mossin, J. (1966). Econometrica: Journal of the econometric society, 768-783. This article explores the equilibrium of a capital asset market by investigating the properties of such market using a simple model of general equilibrium of exchange. In the model, investors attempt to maximize preference functions over the projected yield and their portfolios’ yield variance. The author outlines the theory of market risk premiums where the general equilibrium reveals the existence of a ‘market line’ in relation to expected dollar yield and the standard deviation of the yield. Further, the slope of the ‘market line’ has been used to discuss the concept of risk price.
  • A capital asset pricing model with time-varying covariances, Bollerslev, T., Engle, R. F., & Wooldridge, J. M. (1988). Journal of political Economy, 96(1), 116-131. This study explores the role of capital asset pricing model in the pricing of assets that have uncertain returns. According to the authors, the capital asset pricing model reveals that the premium to induce investors to bear risk is proportional to the non-diversifiable risk. This uncertainty is measured by the asset return covariance and the market portfolio return. It is also found that conditional covariances are quite variable over a period of time and are significant determinats of time-varying risk premia.
  • The capital asset pricing model: Theory and evidence, Fama, E. F., & French, K. R. (2004). Journal of economic perspectives, 18(3), 25-46. This journal explores the capital asset pricing model (CAPM) as proposed by John Lintner and William Sharpe; the model resulted in the invention of the asset pricing theory. According to the authors, there were no asset pricing models prior to CAPM that addressed the nature of investment opportunities and nature of tastes and with clear measurable predictions about risks and returns. After its invention, the CAPM has been used in several applications including estimation of equity capital costs and managed portfolios performance evaluation. The journal also addresses the fact that CAPM does not have an empirical record which has invalidated its application process. Further, a review of the historical background of the CAPM model and the challenges has been addressed.
  • The effect of personal taxes and dividends on capital asset prices: Theory and empirical evidence, Litzenberger, R. H., & Ramaswamy, K. (1979). Journal of financial economics, 7(2), 163-195.  This article introduces the after-tax version of the Capital Asset Pricing Model (CAPM). It illustrates how the model accounts for wealth and income related constraints on borrowing as well as for progressive tax scheme. The authors’ analysis proves that before-tax expected return rates are linearly proportional to the dividend yield and systematic risk. Sample estimates of observed beta variances have been used to obtain maximum likelihood coefficient estimators.
  • A new look at the capital asset pricing model, Blume, M. E., & Friend, I. (1973). The journal of finance, 28(1), 19-34. This paper examines why the market line theory does not explain differential returns of financial assets both theoretically and empirically. First, the authors provide a review of the salient points of the market line theory as modified then analyzes the implications of the theory. The authors then estimate different types of risk-return tradeoffs as implied by the New York Stock Exchange in three different periods after WWII. As such, the authors suggest that the NYSE stocks market is segmented from a bond market except in the case where the return generating process is different.

A liquidity-augmented capital asset pricing model, Liu, W. (2006). Journal of financial Economics, 82(3), 631-671. This paper uses a new liquidity measure to document a significant liquidity premium robust to CAPM model and the Fama-French three-factor model. Based on the analysis, the authors reveal that liquidity is an important source of priced risk. It is explained that a market and liquidity (two-factor) model explains the cross-section of stock returns explaining how liquidity premium exhibit anomalies associated with size, contrarian investment, and fundamental to price ratios. Further, the 2-factor model is shown to explain the book-to-market effect which the Fama-French three-factor model is unable to explain.

Capital asset prices with heterogeneous beliefs, Williams, J. T. (1977). Journal of Financial Economics, 5(2), 219-239. This article discusses the concept of capital asset pricing model, assuming a continuous trading process in a continuous time with Brownian motion processes. By analyzing the model, the authors report the processing of information, and derive the properties of investors’ portfolios.

Capital market equilibrium with restricted borrowing, Black, F. (1972). The Journal of business, 45(3), 444-455. This article describes the capital market equilibrium model that describes the pricing of capital assets which are under market equilibrium conditions. In order to derive the model equations, key assumptions have been made including: all investors have similar options regarding end-of-period values possibilities; the common probability distribution that describes the possible returns on the assets available is jointly stable; investors choose portfolios which maximize the expected end-of-period wealth utility; and investors take long or short position of any size in any asset.

New evidence on the capital asset pricing model, Friend, I., Westerfield, R., & Granito, M. (1978). The Journal of Finance, 33(3), 903-917. This paper explores the capital asset pricing model as discussed by Sharpe and Lintner and uses it to explain the variations in risk differentials on different risky assets. The authors also discuss different theories that have been proposed over the years to explain the discrepancies between the model and actual observations. Evidence on the analysis reveals a reasonably linear correlation between the return and non-diversifiable risk of outstanding common stock.

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