Advantages And Disadvantages Of CAPM
INTRODUCTION
“An investor should receive more returns by investing in riskier securities.” (Mullins, 1982)
Capital Asset Priced Model (CAPM) is a basis of many investments in which it is one of the risk measurement model used by investors to measure their expected returns when they intent to put their money at a risk.
The application of CAPM sparked many theoretical arguments. There were some researchers that agrees that CAPM is valid and went on to further research on it to make it into a better model and there were some researchers that criticizes the theory and went on to argue that it was invalid.
1. THEORETICAL ARGUMENTS OF CAPM
1.1. FAVOURITISM OF CAPM
One of the version of CAPM would be the Black’s version. Using Fisher Black’s version of CAPM, the market betas suffice to explain expected returns and that the risk premium for beta is positive and with this version in his early tests actually shows the positivity of the expected returns.
Other advantages of CAPM would firstly, that it is easy to use by investors as it is a simple calculation that would end up with a range of possible outcomes that may lead to a positive expected return.
Secondly, CAPM is extremely useful when there is a business and risk variability, Weighted average cost of capital (WACC) cannot be used in which CAPM will be used to calculate the returns.
Thirdly, CAPM actually considers systematic risk which are not an important factor in other expected return models. It reflects a reality in
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