A Critique Of The Asset Pricing Theory Essay - 1825 Words

Despite this, however, some have since suggested that their model is pure economics, and is only valid in a theoretical world that doesn’t reflect some of the frictions that actual financial markets do. Richard Roll, and University and Auburn, University of Washington, and University of Chicago educated economist, began his career researching the effect of major events of stock prices. This experience likely helped him reach the two conclusions he makes in his 1977 â€Å"A Critique Of The Asset Pricing Theory’s Tests†, one of the earliest and most influential arguments against CAPM. In the paper, Roll makes two major claims: that CAPM is actually a redundant equation that just further proves the concept of mean-variance efficiency, and that it is impossible to conclusively prove CAPM. His first claim relates to mean-variance efficiency: the idea that mathematically one must be able to create a portfolio that offers the most return for a given amount of risk. Roll claims that all CAPM is doing is testing a portfolio’s mean variance efficiency, and not actually modeling out projected future returns. The second claim in the paper is that there is not enough data ab out market returns for CAPM to ever prove conclusive. Even if modern technologies could help alleviate some of the burden of testing market returns for publicly traded equities, there is still no way to account for the returns of less liquid markets, where there is less public information. This means it is impossible forShow MoreRelatedCapital Asset Pricing Model ( Capm )1552 Words   |  7 PagesIntroduction This essay is mainly focused on Capital Asset Pricing Model (CAPM) and how beta (measure of volatility) influences investment decisions. Nevertheless, how much we diversify our investments, it s impossible to get rid of all the risk. As investors, we deserve a rate of return that compensates us for taking on risk. 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