CAPM
Capital Asset Pricing Model



Portfolio of Stocks with Similar Betas

•After forming portfolios of stocks with similar betas, the subsequent portfolio returns are observed and shown in the following plot.




CAPM Linear Function of Beta



•After forming portfolios of stocks with similar betas, the subsequent portfolio returns are observed and shown in the plot.
•CAPM says expected return is positive, linear functions of beta.
•This plot of actual data shows a positive, linear relation so the model seems to work.
•But CAPM says that beta is the only asset-specific factor that you need to know to estimate expected return. Other factors should add no value in estimating expected return.


CAPM Linear Function of Beta






The lower plot adjusts returns for the effects of size and book to market equity.

After these factors are taken into account, there seems to be no relation between expected return and beta.

The positive linear relationship is gone.



















Last modified: Tuesday, August 14, 2018, 8:46 AM