Presentations of the CAPM often include statements similar to this:
While idiosyncratic risk can be "diversified away", systematic risk cannot, which is also expressed in the CAPM, which states that in equilibrium, asset returns are fully determined by systematic risk.
However, it seems that the CAPM can be derived even in a market with only two risky assets:
The crucial step, which proves the equilibrium — i.e. that it is optimal for any market participant not to change their portfolio — does not rely on the number of assets being large or the possibility to eliminate idiosyncratic risks.
Can this be?
It would imply that most texts (esp. ones aimed at non-mathematical/business audience) give a wrong impression of the connection between CAPM and diversification in portfolio theory...