The Ineffectiveness of Capital Asset Pricing Model and Its Possible Solutions

Abstract

Capital Asset Pricing Model (CAPM) is one of the most widely used models for estimating returns in the investment world. Many relevant studies have shown that CAPM has different validity in different markets. The ineffectiveness of CAPM does exist according in previous studies. Therefore, this article summarized possible reasons for the ineffectiveness of CAPM, which includes the defects of beta measurement, market portfolio measurement, and three model assumptions. In addition, this paper provided several solutions that may help to ameliorate the negative influence of the defects and increase the accuracy of return estimation, specifically, the robust Least Trimmed Squares (LTS) and Maximum Likelihood type M-estimator (MM-estimator) methods can bring to a more accurate beta, while the Fama-French Model may lead to a more appropriate expected return. It is hoped that this article will help investors to build better investment strategies and provide some reference for the researchers who focus on the study of CAPM.