Some academics refute the usefulness of the capital asset priceing Essay

Some academics refute the usefulness of the capital asset priceing model stating that it has a number of empirical problems. critically evaluate this view - Essay Example There are several criticisms on the empirical effectiveness of the CAPM theory viz. the measurement of beta, estimation of market return, difficulties in accessing market portfolio return, reliance on beta as a risk measure, ex ante distribution and ex post population and other unrealistic assumptions underlying the Capital Asset Pricing Model. The model has seriously failed in terms of empirical tests and several studies refute its acceptability as the best asset pricing model. This paper sheds light on the empirical problems and criticisms of the Capital Asset Pricing Model. It evaluates the points put forward by several scholars and discusses the practical applicability of the model. The Capital Asset Pricing Model theory values an asset with respect to its risk (Soufian, 2001). This risk is measured with the help of beta with respect to the overall market risk. Despite its importance and practical usage, some academics point out several problems that are confronted in the empirical testing and application of the CAPM [Fama and French (2004), Michailidis (2006), Ryan (2006), (Soufian, 2001) etc]. Some of the major points of criticism arise out of the measurability of beta, accessibility of the market portfolios, relationship of beta with market returns and the unrealistic assumptions of the model. These criticisms pose several questions on the practical importance of the Capital Asset Pricing Model. The following paragraphs evaluate the various problems regarding the empirical validity of the CAPM. One of the most important factors underlying the Capital Asset Pricing Model is the measurement of beta which is the covariance between an asset’s return and the market return divided by market return’s variance. Hence, estimation of market portfolio return is an integral element of beta measurement. It is however not clear as to what classes of assets to specifically include or not in the portfolio of market