Question

3. Fama and French (1992, 1993) argued that based on more recent data, beta is not helpful in explaining the relationship between risk and return. Their work has received a great deal of attention, both in academic circles and in the popular press, with newspaper articles displaying headlines such as “Beta Is Dead!” If the CAPM is not perfect, why do we continue to use it in corporate finance and investment?

Answer 1

Why CAPM is used?

CAPM is still used in corporate finance & investment for the following reasons:

• While the CAPM is not perfect, it is considered to be straightforward, relatively robust,, manipulation is difficult, correctly emphasizes the importance of market risk. As a result of all these benefits, it is considered to be the best available method for capital budgeting.
• It helps the managers to think about the risk in a correct manner.
• Even if the CAPM is not perfect, it gets the managers to think about risk which the shareholders can eliminate in their portfolios. They should try to focus & compensate the investors on the market risk decisions made by them.
• Methods like NPV are considered to be appropriate for making investment decisions without having any impact on the portfolio of the investors.
• In spite of it limitations, CAPM is considered to be the most popular model for discount rate determination on real investments in the financial sector.