CAPM: Financial Theory & Criticisms

Capital Asset Pricing Model is a financial model that describes how risk and return are related to a particular asset. This model calculates the expected return for an asset as the sum of the risk-free return and a risk premium. It is determined by the asset’s beta. Beta refers to an indicator of volatility relative the market. CAPM’s key assumption is that investors tend to be risk-averse. They will invest only if the expected return on their investment is higher. Investors will expect a greater return on more risky assets according to their beta. The CAPM relies upon the assumption that efficient markets exist, but this may not be true in all cases (Fama 2020). Also, it is not as accurate in assets with low betas and assets located in emerging market (Chen, 2020).