Question

using recent journal articles critically discussing investment anomalies and biases that illustrate investors deviation from CAPM

influence of cognitive affective and social influence and market effeciance

Answer 1

As per CAPM ,it is a best method used to calculate the cost of equity.

CAPM explains the behaviour of the security prices and provides a mechanism whereby investors could assess

the impact of a proposed security investment on their over-all protfolio risk and retun

In otherword CAPM formally describe the risk-required trade off for securities.

The assumptionof capm approach are

1. The efficiency of the security

2.Investor preferences

as per capm

Cost of capital Ke=Risk free return+Beta ( Retrun on market prtfolio-risk free rate)

In valuation of investments, one has to consider his assets in the portfolio as a part of his total investments.

In considering the portfolio, not only returns are to be considered as in the case of single investments but their risks also.

Two plus two will not make it four in the aggregation of risks, as shown by famous author Markowitz.

So the risks in a portfolio of assets will not be the total of individual risks of investments, made; it can be more or less than the total.

The objective of investor is to minimise the risk for a given return and capital market theory deals with that subject.

The Basics of anomalies and biases-investors deviation from CAPM

The equations that comprise the capital asset pricing model are very sensitive to the formula's variable inputs

A small change in the market's rate of return used in the CAPM formula can have a significant impact on the formula's solution.

Because of this and the absence of a true, fully-diversified portfolio, the CAPM formula was considered by Roll to be untestable.

The capital asset pricing model offers a solid foundation for choosing which investments to add to a diversified portfolio,

but after learning of Roll's critique and others, many researchers have moved on to using additional,

different models. Roll's critique is a reminder of the fact that one can only diversify a portfolio so much,

and that investors' attempts to understand and know the market as a whole are just attempts.

Assumptions of CAPM

Aim to maximize economic utilities.

Are rational and risk-averse.

Are broadly diversified across a range of investments.

Are price takers, i.e., they cannot influence prices.

Can lend and borrow unlimited amounts under the risk free rate of interest.

Trade without transaction or taxation costs.

Disadvantages of the CAPM Model

Like many scientific models, the CAPM has its drawbacks. The primary drawbacks are reflected in the model's inputs and assumptions, including

1.Risk-Free Rate (Rf) The commonly accepted rate used as the Rf is the yield on short-term government securities. The issue with using this input is that the yield changes daily, creating volatility.

2.Return on the Market (Rm) The return on the market can be described as the sum of the capital gains and dividends for the market.

3.Ability to Borrow at a Risk-Free Rate CAPM is built on four major assumptions, including one that reflects an unrealistic real-world picture. This assumption—that investors can borrow and lend at a risk-free rate—is unattainable in reality. Individual investors are unable to borrow (or lend) at the same rate as the U.S. government

4.Determination of Project Proxy Beta Businesses that use the CAPM to assess an investment need to find a beta reflective of the project or investment. Often, a proxy beta is necessary. However, accurately determining one to properly assess the project is difficult and can affect the reliability of the outcome.