Norms of Rationality and Investment Decisions: CAPM, Arbitrage and Description Invariance

The classical Capital Asset Pricing Model (CAPM) represents a well-rooted paradigm of rationality for investment decision-making. Following some anticipations in Magni [European Journal of Operational Research 137 (2002) 206] and Magni [AppliedFinancial Economics Letters, forthcoming] this paper shows that decision makers abiding by the CAPM prescriptions violate two other standards of rationality: The arbitrage principle and the principle of description invariance. In particular, referring to investments, (i) the notion of value in the CAPM is incompatible with the one employed in arbitrage theory; (ii) CAPM-minded decision makers may fail to exploit arbitrage opportunities; (iii)the principle of additivity is not fulfilled in CAPM-based asset valuation; (iii) the notion of value derived from CAPM is senseless; (iv) CAPM-minded agents fall prey to framingeffects. In other terms, this paper fosters the idea that economic agents complying with this consolidated paradigm of valuation and decision-making exhibit biases in investmentvaluation and choice.