According to the Capital Asset Pricing Model (CAPM), what is the rationale behind investor behavior?

The rationale behind investor behavior according to the Capital Asset Pricing Model (CAPM) centers on the relationship between risk and expected return. CAPM posits that investors require a premium for taking on additional risk, which is quantified in relation to the market's systematic risk, represented by beta. This model emphasizes that investors are rational and will only invest in assets if they believe that the expected return justifies the risk involved.

The correct answer indicates that investors are not willing to reward premium returns to companies that are diversified. This stems from the notion that truly diversified investments reduce unsystematic risk, and therefore, investors do not demand additional returns for taking on that risk. They understand that adequate diversification leads to more stable and predictable returns, which can often detract from the premium returns that would otherwise be required for higher-risk investments.

In contrast, the other choices suggest different investor behaviors that do not align with the fundamental principles of CAPM, such as concentrating investments to minimize risk or focusing only on short-term gains, which overlooks the importance of long-term expectations in capital markets. Thus, the correct answer reflects a deeper understanding of how investors evaluate risk and return based on diversification and market behavior, as articulated in the CAPM framework.