Beyond The Capital Asset Pricing Model

The capital asset pricing model (CAPM) introduced by Jack Treynor, William Sharpe, John Lintner and Jan Mossin in 1972[2]is an important method to predict the risk and return in assets. Nowadays, the CAPM is still widely used in applications as it is a so simple and attractive tool. However it has the problems in many circumstances and we need some other extended and available models to evaluate the risk and return of assets.

We know that CAPM is a model used to price an individual security or portfolio under many strict assumptions. It is no doubt that it gives a simple model as there are a lot of assumptions[9].Although it is a main tool used to analyse the security market, the problems of it are very significant. In order to analyse these problems, we compare the CAPM model with the APT model firstly.

Unlike the CAPM, the number of assumptions in APT is fewer than that of CAPM[6]. But it has more estimators than the CAPM which can be seen from the formula below:

R=RF+ (R1-RF)×β1+(R2-RF)× β2 +(R3-RF)×β3+…(RK-RF)×βk

In this equation, the β1, represents for the beta to the first factor, β2 represents the beta to the second factor and so on. The factors can be GNP, inflation, interest rate of the systematic risk[7]. Quite different from the CAPM, we can see from the equation that the APT has many betas respect to factors of systematic risk. However, we have to estimate only one beta in CAPM. And it can be shown clearly by the following equation:

R=RF+ β×(RM-RF)

The β in CAPM is a parameter which plays an important role in modern finance as a means to estimate the risk of assets. Given the definition of beta in the book of Modern Financial Management[9],we know that the beta here means the responsiveness of the security’s r...

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[6] SA Ross. Arbitrage Theory of Asset Pricing, Journal of Economic Theory, 1976.

[7] Stephen A. Ross, Randolph W. Westerfield, Jeffrey F.Jaffe and Bradford D. Jordan. Modern Financial Management, pp. 333.

[8] Sanford J. Grossman and Joseph E. Stiglitz. Information and Competitive Price Systems, The American Economic Review, pp. 246-253.

[9] Stephen A. Ross, Randolph W. Westerfield, Jeffrey F.Jaffe and Bradford D. Jordan. Modern Financial Management, pp. 307-309;341.

[10] Xharles Kramer. Macroeconomic Seasonality and the January Effect, The Journal of business, 49, pp. 1883-1891.