Reprint Abstract:
The capital asset pricing model (CAPM) offers predictions about how to measure risk and relation
between expected return and risk. However, its poor empirical results invalidate its use in application.
Early tests on risk premium and whether market betas explains expected returns couple with recent tests
on the relationship between variation in expected return and market beta prove the conclusion. The
problem is caused by many simplifying assumptions and difficulties in implementing valid tests of the
model. The problem may be explained by investors’ overreaction and the need for a more complicated
asset pricing model.
Discussion:
There have been many empirical tests challenging the effectiveness of CAPM tough the model still be
widely used in investment analysis. I agree with the conclusion of this paper, which is CAPM fails in
many empirical tests and shows poor effectiveness in its application. The paper discusses two main
reasons explaining the failure. One is the assumptions of the model and another is the difficulties in
implementing valid tests. I believe that unrealistic assumption is the main reason and it leads to other
reasons explaining the final conclusion. Nearly all the models would meet difficulties while applying in
reality mostly because of the assumptions. The paper points out that “all interesting models involve
unrealistic simplifications, which is why they must be tested against data”. Those assumptions, no matter
what, simplify the model and make it looks more accurate and applicable. Sometimes the model is
through a lot of experiment data correction, and constantly be improved to redesign. Model’s assumptions
