Question

"The CAPM is a good measure of risk and thus a good explanation of the fact that some assets (stocks, portfolios, strategies, or mutual funds) earn higher average returns than others" Comment

Answer 1

Earlier it was believed that the CAPM is a good measure of risk and provides a good explanation of why some assets earn a higher return than the others.

Earlier it was believed that the pure expectations the holds true and the long term interest rates , reflect fully the expectations of the short term interest rates into the future. earlier it was believed that the exchange rate differentials is truly reflected in the exchange rate, but later on it was found that the time -risk premium also affects the exchange rates. We believed that average returns of the MUTUAL FUNDS are completely explained by the CAPM, but now it is believed that funds have earned above average returns which is not explained by the CAPM.

CAPM only explaines  the returns earned by the security and the systematic risk it was exposed to . CAPM does not explain the returns that a fund can earn due to interest rate changes, currency fluctuations and dividends.

Investors are not only compensated for the systematic risks but also for holding securities in times of recession or financial distress. These other sources of returns for an investor is not explained by the CAPM which only explains the returns of a security due to overall market movements.  

TO overcome the weakness of the CAPM and to take into account international movements ,the ICAPM was formulated. ICAPM is far more useful than CAPM in practice. There has been a growth of other multifactor models also to take account the additional risk factors apart of systematic risks that affect average returns.