The Capital Asset Pricing Model: A New Look on Risk -Reward Relationship, Beta Estimation, Further Evidence on the Validity and Scientifically Based Applications.

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Rajib Mallik


All over the world, the vigorous development of the securities industry has introduced a large number of theories related to securities investment analysis. In this connection, the theoretical basis of securities analysis mainly includes Markowitz (1952) Asset Portfolio Theory, Sharpe (1964) Capital Asset Pricing Model (CAPM) and Ross (1976) Arbitrage Pricing Model (APT). Among these models, CAPM is a classic model in people's hearts and minds. The model is widely used in the various stock markets and financial investment markets, especially for riskier investments.  It is used to determine the required rate of return of an asset, to make decisions about adding assets to a well-diversified portfolio. The model is represented by the beta coefficient which measures the sensitivity of the financial instrument in relation to the systematic risk. But, CAPM’s critics point out that, it makes unrealistic assumptions and beta does not acknowledge that price swings in either direction don’t hold equal risk. Bedside this, using a particular period for risk assessment ignores that risk and returns do not distribute evenly over time. Thus, many experts, researchers, academicians and investors have doubt regarding current validity of the model. In this context, the study is felt necessary to bring a new look on the theory.  The study reviewed the theory, framework and evidence of the Capital Asset Pricing Model (CAPM). The applications of this model have been analyzed from different perspectives. In this context, the measurement and use of beta coefficients for stock predictions were also discussed. It has also exposed a rational assessment between Security Market Line (SML) and Capital Market Line (CML). Beside this, the study showed that, the Security Market Line (SML) may be instigated from Capital Market Line (CML) and vice- versa. Furthermore, the Arbitrage Pricing Theory (APT) has also been described as an additional evidence of CAPM. Overall, the study critically analysed the beta estimation and a new look on risk -reward relationship for assets, particularly stocks. 

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