Question

What are the key estimates used in CAPM? Why is this measure so harshly criticized? Do you agree with the critics? Why or why not?

Answer 1

Answer-

The assumptions or estimates of CAPM are

1) investors are risk averse, utility maximizing and rational
2) markets are frictionless ie. cost and taxes
3) All the investors plan to use the same time period
4) All investots have same expectations of returns
5) Investments that are indefinitely divisible
6) Prices are unaffected by an investors trades

The CAPM has disadvantages

1) This model assumes that the asset returns are normally distributed random variables
2) Assumption of variance of freturns is the adequate measure of risk
3) Does not explain the variation of stock returns
4) assumption that given an expected return the invesrtors will prefer lower risk to higher risk and conversely at a certain level of risk will prefer higher returns to lower returns
5) Determination of project proxy beta

Yes the CAPM has disadvantages as it takes into condsideration only the systematic risk and the estimation of beta is not properly done which leads to the cost of equity that is not accurate.