Strengths And Weaknesses Of The CAPM And APT Model
Strengths and weaknesses of the CAPM and APT model as practical methods of asset pricing. The Capital Asset Pricing Model has it 's history starting from 1959, when it all started from Harry Markowitz, who was particularly interested in modern portfolio theory and diversification, following by work of Jack Treynor, William F.Sharpe, John Linthner and Jam Mossin, who introduced this particular model later in 1965 (Steven Nickolas, 2016). The formula that is used in that model represents the correlation between the risk and expected return of the given risky asset. Furthermore CAPM model highlights the value of diversification of systematic risk, which in theory can not disappear. A good example of that type of risk would be a conflict between countries, unsuccessful economic activity, such as a recession. This becomes a problem due to the fact that CAPM model does not take into account any unsystematic risk. The CAPM model for the given financial asset ”a” is represented by the given formula, which is also known as the capital market line: E(Ra) = Rf + βa ( E(Ra) - Rf ), where: 1) E(Ra) shows the return required on the financial asset ”a” 2) Rf represents the risk-free rate of return 3) βa gives us the beta value for the financial asset ”a”, where if this asset is very risky, it should have the value of higher that one because it can easily be influenced by the market, and vice versa. 4) E(Ra) describes the average return for the given capital market. It is
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