Separating Risk and Return in the CAPM: A General Utility-based Model

Motivated by developments in risk-value theory, the author proposes a new utility function which can capture trade-offs between favourable notions of risk and return while exhibiting desirable properties for a financial investor. This function is shown to be sufficient for two fund money separation and forms the basis for an extension to the Capital Asset Pricing Model which contains as special cases many other such extensions, in particular those relying upon downside risk measurement. Finally, given the properties of the utility function, the results offer a natural link between axiomatised risk measures, risk-return separation and equilibrium asset pricing.