The Capital Asset Pricing Model

Problems with CAPM

There are several assumptions with CAPM that have been proven to not hold in reality. CAPM assumes that markets are competitive and efficient, meaning that new information is quickly priced into stocks. 

However, it is widely accepted that markets are semi-strong form efficient and that there is a delay in the absorption of new information by the market – meaning that it is hard to reliably measure the market. 

CAPM also assumes that investors are rational and risk-averse, seeking to maximize satisfaction from their investment returns. This is unlikely to be true as there is a variety of market participants.   

Including Beta in the CAPM formula assumes that risk can be measured by a stock’s price volatility. However, this changes over time, meaning that the outcomes of CAPM can easily become outdated. 

Copyright © 2021 Methodology

That's wrong - try again!