THE CAPITAL ASSET PRICING MODEL

THE CAPITAL ASSET PRICING MODEL

‘The Capital Asset Pricing Model (CAPM)’ has dominated academic literature and greatly
influenced the practical world of finance and business for almost half a century; as a way to
measure systematic risk. Researchers in the 1980s and 1990s have questioned the relationship
between systematic risk, measure beta, and returns on securities. Despite heavy criticism of
the model from the academic community, CAPM has reached new heights of popularity in
the outside world (Arnold pp 269). Hundreds of thousands have studied the CAPM in
universities and now hold key positions ready to make decisions based on the model. Does
CAPM-beta really provide the answer to the risk-return relationship? Does CAPM provide a
good account for pricing a firm’s debt or equity? Hence is CAPM of relevance to corporate
managers?
Explain and discuss this contention
The assignment should be no longer than 1000 words and should be submitted by,
Friday, 27th February 2015.
Note:
This is an individual assignment. The minimum accreditation thresholds of 35% apply, in
addition to the overall 40% pass mark requirement. This assignment comprises 15% of your
overall mark.
Assignment must be submitted through Turnitin prior to hard copy submission to the
undergraduate centre. Please note that the Turnitin match must not materially exceed
20%.
Assignment Suggestion
______________________________________________________________
This assignment relates to the lecture on portfolio theory and the capital asset pricing model.
To answer it satisfactorily, you will need to give some thought to the question and to discuss
the relationship between risk and return, define the fundamental features of the capital asset
pricing model and discuss the empirical evidence relating to the CAPM. The main body of
your report should focus on why the academic community are turning away from the CAPM.
The latter part of the question requires more thought, and you should try to highlight features
of the CAPM which lends itself to the context of corporate managers. In the development of
your answer you are expected to include relevant economic and financial concepts and where
appropriate (you may if you wish make use of relevant diagrams).
Finally remember imperfect English is infinitely preferable to plagiarism!
Portsmouth Business School
P23361
Financial Management
References
Black, F., Jensen, M. C., & Scholes, M. (1972). The Capital Asset Pricing Model:some
empirical tests. Studies in the Theory of Capital Markets .
Blume, M., & Friend, I. (1973). A new look at teh Capital Asset Pricing Model. Journal of
Finance , 28 (1), 19-33.
Elton, E., Gruber, M., Brown, S., & Goetzmann, W. (2011). Modern Portfolio Theory and
Investment Analysis. New York: Wiley & Sons.
Fama, G., & French, K. (1992). The Cross-section of expected stock returns. Journal of
Finance , 427-465.
Friend, I., Westerfield, R., & Gra, M. (1978). New Evidence on the Capital Asset Pricing
Model. The Journal of Finance , 33 (3, Papers and Proceedings of the Thirty-SixthAnnual
Meeting American Finance Association), 903-917.
Roll, R. (1977). A critique of the Asset Pricing Theory’s tests:Part 1: On past and potential
testability of the theory. Journal of Financial Economics , 129-176.
Sharpe, W. F. (1964). Capital asset prices:a theory of market equilibrium under conditions of
risk. Journal of Finance , 425-442.
Portsmouth Business School
P23361
Financial Management
Students are reminded that the definition of plagiarism includes claiming another person’s work as
your own; for example through inadequate references of sources of material used (including internet
sources). Direct quotations must be enclosed in quotation marks and referenced. Using other
people’s ideas requires a reference even if a direct quote is not included.

Learning outcomes
• Discuss the empirical evidence relating to
CAPM
• Why is the academic community turning against
CAPM?
• Explore alternatives e.g. multi-factor models;
include arbitrage pricing model and the threefactor model Alternatives
• Coursework guidance
Assumptions of CAPM
• No transaction costs (frictionless markets)
• Assets are infinitely divisible (any investor
can take any position regardless of wealth)
• No personal taxes
• No single investor can affect the stock price –
i.e. one can buy/sell any amounts
• Unlimited short sales are allowed
• Unlimited lending/borrowing at risk free
• Homogeneity of expectations – mean and
variance of returns, relevant periods,
inputs
• All assets are marketable (including human capital)
• Only portfolio of risky assets an investor will
hold is the market portfolio
D Assumptions do not hold in the REAL
WORLD?????
Technical problems with the CAPM
Does the CAPM work in practice?
Does the CAPM work in practice?
Does the CAPM work in practice?
Beta and returns, 1931-91
Beta and Returns, 1966-91
Alternative forms of capital asset
pricing models
Factor Models
Arbitrage Pricing Theory
FF3 Factor model
Assignment briefing
• A 1000 word critical thinking essay on CAPM
• Individual assignment
• 15% of unit marks for Financial Management
students
• 20% of unit for Financial Management for Non
Accountant Students
• Deadline is 27 February 2015
• Submitted via Turnitin and paper copy to UGO
What is Critical thinking?
It involves weighing up the arguments and
evidence for and against something.
“Critical thinking calls for persistent effort to
examine any belief or supposed form of
knowledge in the light of the evidence that
supports it and the further conclusions to which
it tends”.
(Glaser, 1941)
Glaser’s priorities for critical thinking
• Persistence – considering an issue carefully and
more than once, probably over a period of time
• Evidence – evaluating the evidence put forward
in support of or against a belief or viewpoint
• Implications •



considering where the belief or viewpoint leads
what conclusions would follow
whether these conclusions are suitable and rational
if not should the belief or viewpoint be reconsidered?
Critical Questions






Why?
How far?
How much?
How often?
To what extent?
How do we know this is
true?
• How reliable is this
source?
• What could be going on
below the surface?
• What do we know
about this?
• Which is preferable?
• For what reasons?
Essay content




Relates to Portfolio theory and CAPM
Understanding of Risk and return
Brief description of features of both models
Why is the academic community turning away?
Main body of the essay, be critical, for and
against.
• Set the analysis in the context of the finance
managers role
• Use diagrams
Marking schedule
• A marking schedule is attached to the
question as a guide
• This shows you what you have to achieve to
get a good grade in this essay
• Please use turnitin in advance to check your
essay prior to submission
• Turnitin space on moodle where you can
submit for checking
Turnitin
• Turnitin will check what sources you have
used and how many
• It will also check your referencing
• It can spot cutting and pasting
• Preferable to use your own words

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