Advantages and disadvantages of capital asset pricing model

Advantages of capital asset pricing model:

The greatest contribution of capital asset pricing model is that it provides a substantial expression between risk and return. For the first time, the capital asset pricing model expresses an intuitive understanding that "high returns are accompanied by high risks" with such a simple relationship.

So far, the capital asset pricing model is the most appropriate expression of the relationship between risk and return in reality.

Shortcomings of capital asset pricing model:

It is difficult to estimate the β value of some assets or enterprises, especially some emerging industries that lack historical data.

With the uncertainty and constant change of economic environment, the β value estimated based on historical data is bound to play less guiding role in the future-tongjitang.

The capital asset pricing model is based on a series of assumptions, some of which are quite different from the actual situation, which makes the effectiveness of the capital asset pricing model questioned. These assumptions include: the market is balanced, there is no friction in the market, market participants are rational, there is no transaction cost, and taxes do not affect the choice and transaction of assets.

Basic principles of capital asset pricing model;

R=Rf+β×(Rm—Rf)

R represents the necessary rate of return of an asset;

β represents the systematic risk coefficient of assets;

Rf stands for risk-free rate of return, which is usually approximately replaced by short-term national debt interest rate;

Rm stands for the market portfolio return rate, which is usually replaced by the average return rate of stock price index or the average return rate of all stocks; (RM-RF) is called market risk premium.