Question

While the Capital Asset Pricing Model (CAPM) has been widely used to analyze securities and manage portfolios for the past 50 years, it has also been widely criticized as providing too simple a view of risk. Describe three problems in relation to the definition and estimation of the beta measure in the CAPM that would support this criticizm.

Answer 1

1. Risk-Free Rate of Borrowing

CAPM is based on a presumptions that mirrors an unrealistic genuine picture. This supposition—that investors can acquire and lend at a risk-free rate—is out of reach as a general rule. Individual investors can't obtain or lend at a similar rate as the U.S. government. In this way, the required return line may really be less steep than the model computes (given a lower return).

2. Project Proxy Beta

Organizations need to find a beta reflective of the investment or project, if they are using the CAPM to evaluate an investment. Frequently, a proxy beta is essential. Be that as it may, accurately deciding one to appropriately assess the project is troublesome and can influence the trustworthiness of the result.

3. (Rm) Return on the Market

Return on the market is the entirety of the capital gains and profits for the market. An issue is that these returns are in reverse looking and may not be illustrative of future market returns. Another issue emerges when the market return can be negative. So to smooth the return, a long-term market return is used.