Advantages And Limitations Of CAPM

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Uses and Iimitations of the CAPM Introduction Graham and Harvey surveyed the CFOs of 392 U.S. firms and found that when estimating the capital of assets,73.5% of respondents use the CAPM.( Graham, J. R., and C. R. Harvey,2001) It is a model which uses simple formula to evaluate asset pricing and investor behavior. This model is absolutely the method with most investors used, but many financial experts raise an objection to the veracity of this method in the recent years. Later in the main body of the essay will discuss these questions. In the first part of the essay will introduce the CAPM and the main factor of this method. Secondly, is the discussion of the uses and limits of the CAPM while evaluating the potential investment of a firm 's…show more content…
(Hillier, Ross, and Westerfield, 2010)And they use CAPM to compare stocks ' expected return estimated by CAPM to buy the cheapest stock. Beta coefficient is the most difficult estimated value in CAPM and this is the most important value in CAPM which used to measure the market risk of an asset. Beta is 1 when the percent of change of share price and market price are the same. When the Beta is larger than 1. For example, beta is 2.0 means when the market price increase by 10% then the share price will increase 20% and vice versa. Therefore, investors can invest their money in those stocks with lower beta when the market price decrease and invest in stocks with beta larger than 1 when the market price increase. This model is widely used in Investment. Beta is calculated with historical data and the length of data is also very important to the variance of beta. The longer the time the more stable the variance is. However, if the term is too long, the change of business operation, market, technology, competitive force and the feature of the market will affect the value of beta. Besides, many popular index funds give investors a chance to hold diversification at low cost. Limitation of CAPM while estimating the potential investment of a firm 's share from investors ' point of view. The assumptions of CAPM is the limitation of this

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