A perfect capital market is a key assumption in recent theories of security pricing. It is assumed that the costs of transactions, information-gathering, and portfolio management are all zero, and that no investor is so large as to exert an appreciable effect on either the risk-free interest rate or the yield on risky securities. If, in this perfect capital market, investors have identical decision horizons and homogeneous expectations, then there is a unique optimal portfolio of risky securities. Since this unique portfolio must include every security in proportion to its relative valuation in the capital market, it is referred to as the “market” portfolio. When the capital market reaches equilibrium, the expected return of every security will be a linear function of the expected return of the market portfolio. From this relationship Lintner and Mossin have separately derived valuation formulas that express the market price of a security as a function of the security[s end-of-period expected value, its risk as measured by the variance and covariances of this end-of-period value, the market price of risk within the portfolio, and the risk-free rate of interest.

Markowitz's [2] portfolio selection model was originally concerned with financial investments, but the model's implications for capital budgeting are now well recognized. Markowitz's basic idea is that the optimal portfolio for an investor is not simply any collection of good securities, but a balanced whole, providing the investor with the best combination of “return” and “risk.” Return and risk are to be measured by the expected value and variance of the probability distribution of portfolio return. Although financial writers have generally accepted Markowitz's measure of return, they have not been completely satisfied with his suggested measure of risk [1]. In fact, Markowitz himself had reservations about choosing variance as a measure of risk.1 Besides variance, he considered five other alternative measures of risk:(1) The expected value of loss;(2) The probability of loss;(3) The expected absolute deviation;(4) The maximum expected loss; and(5) The semivariance.