The Capital Asset Pricing Method (CAPM) Essay Example | Topics and Well Written Essays - 1750 words - 10

The Capital Asset Pricing Method (CAPM) - Essay Example The present research has identified that the CAPM model does not wholly explain the returns on investment portfolios. A number of assumptions have to be identified for CAPM equilibrium to be achieved. The assumptions include the fact that investors must have the same expectations and also apply similar input list, they also have to maximize their estimated utility of wealth, the investors have to plan for a homogenous holding period, no transaction costs or taxes are incurred, the rate of borrowing equals the rate of lending and that there exists an environment where there is availability of numerous investors each having an endowment of wealth that is small in comparison to the whole endowment. When the model was developed, a variety of empirical tests were conducted on the model by using proxies and a number showed that the model was unsuitable and inaccurate when predicting the prices of assets and in many situations did not hold. However, it was later asserted that the model was theoretically probable but was very hard, by using empirical tests to prove because stock indexes coupled with other market measures were not adequate proxies for the variables of the CAPM model. The Capital Asset Pricing Method makes use of a variety of assumptions regarding the behavior of the investor and market in order to provide a group of equilibrium conditions which enable people to estimate the expected return of an asset I compare to its non-diversifiable risk. The model makes use of systematic risk measure in order to facilitate a comparison between the assets in consideration and other assets in the market. Theoretically, using the systematic measure of risk it enables managers to calculate their needed rate of return while also assisting investors to better their portfolios.