“Characteristics, Assumptions and Criticism of Capm”

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Academic Year 2003-04

Year 3/1ο Semester

FOUNDATION OF FINANCIAL MARKETS AND INSTITUTION

“Characteristics, assumptions and criticism of CAPM”

Submitted to: Mr.X.Raris

Submitted by: Sofia Stagia

Submission date: 24 February 2004

CONTENTS

1. Introduction page 3

2. Implementation of CAPM page 3

3. Assumptions of CAPM page 4

4. The advantages and disadvantages of CAPM page 4

5. Criticism of CAPM Implementation page 5

6. Conclusion page 7

7. Sources page 8

INTRODUCTION

In 1952, Harry Markowitz first developed the Capital Asset pricing Model. After some years, William Sharpe, John Lintner and Jack Treynor fully completed the development of this model. Originally designed as an explanatory and predictive model of market behaviour, it has since acquired enormous significance in fund management, and security pricing institutions. The Capital Asset Pricing Model is based on elementary logic and simple economic principles. The basic postulate underlying this finance theory is that there is a linear relationship between the required (or expected) return on an individual portfolio and the risk associated with that portfolio, measured by its volatility relative to a broad market index.

IMPLEMENTATION OF CAPM

Capital Asset Pricing Model describes the relationship between risk and expected return. It is a tool that calculates the price of risky securities. According to the CAPM equation, the expected return of a security or a portfolio is equal to the rate on a risk-free security plus a risk premium. Whether, the expected...